We are getting some inquiries from nervous clients about the stock market in the weeks and months immediately ahead.  What do we think right now?

The stock market is not expensive.  By most metrics it is fairly valued–not cheap but not overvalued either.  There is much loose talk about stock prices being at an all-time high, but when measured on the basis of dividends and earnings it is half as expensive as it was in 2000 and about two-thirds as expensive as it was in 2007 before the bottom fell out.  Also, the stock market still has no competition from bonds.  Even after the big bond sell-off at the end of June, the 10-year Treasury note still only yields 2.6%.  Coca Cola, Nestles, Procter & Gamble, McDonald’s etc. have dividends higher than that.  And the price of gold has been falling at a time when it should be rising.  It’s incoherent price action disqualifies it, in my opinion, as a prudent alternative to stocks and bonds.

At the start of this year the most bullish observers  thought the market might go up 10% by year end.  I think it’s safe to say that most people thought it would be a bad year, maybe even a very bad year.  We know what happened next. The market rose almost 20%, twice what the most optimistic forecasts thought possible.  Thus we would not be surprised to see a pullback this fall (also called a correction), especially in light of some things looming on the horizon, like another fight over the federal budget and the debt ceiling, the tapering off of quantitative easing (aka printing money), and the German elections (what if they go against Germany paying for the excesses of other EU countries?).  But markets pull back all the time.  Politicians and the Federal Reserve Board are always trying to avoid the normal business cycle.  Our system seems to need to take breathers from time to time.  Thus stock market pullback, if we get one,  doesn’t mean the system is broken.  It’s a necessary corrective.

That having been said, what would I do?  If you have a fixed and certain liability coming due this fall, like a college tuition payment, I would take the opportunity to sell some stock to cover it.  But if you are a long term investor, I’d stay invested in high-quality American stocks that pay a dividend, like those I mentioned above.  I’d probably go very lightly with bonds, which do seem overvalued.

Mark O’Brien