The one question every investor wants answered: Are stocks in a bubble?
We've put the question to a number of our on-air guests recently, based on a +29 percent rally year-to-date which has lifted the S&P 500 index to an all-time high.
Today we offer our own response by comparing the S&P 500 to a series of other relevant indicators, beginning with the 10-year Treasury yield. Conventional wisdom might suggest rising rates hamper growth by causing higher borrowing costs. However a closer look at the data shows five extended periods during the past 25 years (shaded area) when both stocks and bonds rallied together.
In each case, GDP was also rising, so rates were simply reflecting economic expansion. Given the recent acceleration to 4.1 percent growth here in the U.S., and the IMF's decision to raise its global forecast, we believe the current 10-year move above 3 percent bodes well for stocks.
Today's 30-month high of 3.01 percent is accompanied by another significant high: a net bullish reading of 55 percent among individual investors (Bulls minus Bears) based on AAII weekly surveys. This is the highest reading since December of 2004. Again, conventional wisdom might suggest cause for concern, on the assumption an abundance of bulls means fewer investors left to buy. However, we would challenge blog readers to find any correlation between sentiment and stocks. Bullish or otherwise, we think weekly sentiment readings are irrelevant noise.
We've also heard much debate about valuation. Bloomberg tracks the 21 Wall Street strategists who provide earnings estimates and price targets for the S&P 500. Collectively, they forecast 2014 earnings of $116.78 and a year end target of 1,946, both about 5.5% above current levels. Applying the earnings figure of $116.78 to the current S&P 500 price of 1844, stocks are trading at a P/E ratio of 15.8x (1844/116.78).
Comparing this estimated P/E ratio to the market's P/E of the past 25 years, stocks are hardly "overvalued." In fact, they're in the middle of the range. Once again, little cause for concern.
We remain positive on stocks into 2014, and appreciate readers' loyal support this year. Thank you!
Also, we will be attending this year's Renaissance Weekend in Charleston, so we will not publish on Monday and Tuesday. We will see you again on Thursday. Have a great New Years.