The S&P 500 and the Dow Jones industrial average closed at record highs Thursday. Though there could be a double-digit retrenchment, the market is being propelled by some powerful positive forces.
Photos by Richard Drew , Associated Press
John Feste is the managing principal at Marks Group Wealth Management in Minnetonka. His e-mail is email@example.com.
Business forum: We're here, but we're not there yet
- Article by: JOHN FESTE
- March 31, 2013 - 7:20 PM
About a year ago, I wrote in this space that markets climb a “wall of worry” and that, despite the negative headlines and choppiness of the slow recovery in stocks we were seeing at the time, we were becoming increasingly confident that the market would make it out of the hole into which it fell in late 2008 and early 2009.
It’s always nice to be right. But with the Dow Jones industrial average and the S&P 500 both closing at record highs last week human nature again takes hold — we worry. We worry that the party’s over and that we’re again about to head down another hill.
Consider the evidence. In the past three months, investors have largely ignored such seemingly existential threats as the “fiscal cliff,” and the “great sequestration.” Cypress is teetering on the brink of financial collapse, with worries emanating that its banking crisis could trigger a broader panic. China’s new leader is openly calling for reform in both its government and Chinese financial markets as the world’s second-largest economy struggles with slower growth.
So does all this mean that stocks are overvalued? Yes, some are. But as far as the overall market, we think not. To be sure, we’ve benefitted not only from the proverbial “January effect,” but also a “February effect” and now a bit of “March madness” — a refreshing change from prior years when rallies early in the year gave way to pessimism and lackluster performance in the latter part of the year.
Could that happen again? Of course. Is it likely to happen again? Probably. Remember the “wall of worry”? The fact is, the market is forever torn by a fundamental conflict. On the one hand, it is made up of millions of investors, each with a different motivation — and for many that translates into short-term profit-taking that can, collectively, result in pullbacks, both in individual stocks and in the broader indexes.
Example: Best Buy — back in January, BBY sure looked pretty cheap at $12, as the company wrestled with the uncertainty of a new management team, the question of whether former chairman and CEO Richard Schulze was going to mount a takeover battle (a costly proposition for both sides), and the question of whether the company was going to be able to pull out of its slide in same-store sales.
As a result, some investors made a contrarian bet and bought the stock, setting some arbitrary exit point. BBY is now trading north of $21. Is it a candidate for a pullback? Absolutely. Someone is sitting out there with a nearly $10-a-share gain — a powerful incentive to sell, regardless of any fundamentals that may support holding onto the stock.
Can this happen to the entire market? Perhaps. But this doesn’t mean you should call your financial advisers and ask them to sell everything.
While at some point we could see a double-digit retrenchment in the market, we see that as an occasion when the weak hands will fold and buying opportunities may present themselves. This year, the market is being propelled by some powerful positive forces.
One is a genuine resurgence in the housing market, which is not only contributing to the wealth effect people feel regarding their financial health, but also helps industries that contribute to housing — lumber and construction, building supplies, land values and the tax revenue generated by that activity.
In addition, individual investors are returning to the stock market. Importantly, we’d argue that the money they are plowing into the market isn’t yet part of the much-anticipated “great rotation” from bonds into stocks. Rather, it’s money from cash accounts — a shift driven by individuals and institutions that marks only the beginning of a reallocation of assets that could last, literally, for a couple of years.
Finally, there’s the whole question of valuations. The last time the market was trading at these levels, stocks were being valued at well over 16 times forward earnings. This time, stocks are comfortably valued near 13 times forward earnings. We believe valuations will move toward 15 to 16 times forward earnings, as they have done historically.
Yes, the indexes are at record highs. But we think there’s more room to grow. Markets seldom move in straight lines up. So we could — and probably will — experience some volatility, as markets digest and consolidate their recent gains.
But this isn’t the end, by any means. We’re here, but we’re not there yet.
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