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Buy the Dips: This Bull Market's Not Over - views
BALTIMORE (Stockpickr) -- The bears are back in town. Or rather, they never left. But after the last five straight days of selling, they sure are getting louder.
Despite a rip-roaring market in 2013, the S&P 500 is due for higher highs yet to come. The bears are wrong. Here's why.
Look, there's no question that we've been in the midst of a historic rally for the past eleven months. Year-to-date, the S&P 500 has climbed a whopping 25.3% as I write. If we closed the books now, it'd be the best year for the big index in a full decade. Get rid of the calendar-year constraints and the rally extends more than 30% since last November's lows.
At some point, we've got to wonder, "How high can it go?"
First things first, I'm no journalist. In my day job, I manage stock portfolios -- so yes, I'm talking my book right now. And needless to say, it's been a blockbuster year for investors who were allocated to stocks early on, and a bloodbath for those who were underexposed, and playing catch-up ever since.
The thing is, even though it seems like bears are only starting to come out en masse now, many of the most vocal ones have been betting against this market all the way up. I'll be the first to admit that even the best professional investors are wrong sometimes (or even frequently), but missing the biggest equity rally in a decade is a whole nother level.
Keep that in mind the next time you hear stocks are doomed.
But there's a difference between feeling like the market's moved up too far too fast, and having the data to back it up. When you invest by "feel," you subject yourself to bias -- we all do. So I'll stick to the facts today.
Stocks Are Expensive, Right?
The first question we need to ask ourselves is whether or not stocks are too expensive from a value standpoint. If they are, then maybe there's something to the bear argument after all.
But looking back, the S&P 500 is within a pretty reasonable range of its average. As I write, the forward price-to-earnings ratio for the big index sits at 16.23. That's even lower than the average forward P/E of 16.6 over the last three decades. Remember, though, forward P/Es are estimated -- focus on past earnings, and that number gets pushed up to a much more hefty 18.7.
Compared with our long-term average of 16.6, that's a relatively high number. The bears are salivating now.
But what that number doesn't account for is cash. And companies have a lot of it right now -- more, in fact, than ever before in history. As I write, cash on corporate balance sheets covers around 25% of the current value of the S&P 500.
I'll say that again for emphasis: A full quarter of the S&P 500's current price tag is paid for by cash on hand alone. Adjust for that huge base of risk-free assets, and suddenly stocks don't look quite so pricey anymore.
But wait, say the bears, regular old P/E isn't a good measure of value. Instead, Shiller P/E offers a much better number -- it shows that the S&P 500 is overpriced. Shiller P/E, or CAPE, normalizes earnings over a decade to avoid the pitfalls of unsustainable profits. With CAPE sitting around 24.4 right now, stocks have to be overpriced!
But there's just one problem with that argument: Smack dab in the middle of that 10-year data series, we have a prolonged and extreme economic recession with the income statement carnage that comes from de-levering balance sheets. So while earnings bounced back to new highs in the years that followed, Shiller P/E's cyclical earnings include a very temporary earnings event caused by GAAP accounting rules rather than true earnings changes.
Translation: Of course stocks look overpriced with Shiller P/E. It takes the new high stock prices of today, and compares them to misleadingly low earnings from the great recession.
Normalizing earnings using one of the most abnormal earnings periods in history is like zeroing your bathroom scale with a cinder block on it.
Bring on the Dividends
If you want more proof that stocks aren't expensive, look no further than dividends.
Right now, companies are paying out dividends in a big way. Not only are more firms paying dividends to shareholders, but the dividend yield of the S&P 500 is currently at the highest sustained level it's been in since the early 1990s.
Perhaps most important, this is all happening in the context of a near-zero interest rate environment. For the first time in more than four decades, the S&P's dividend yield is higher than the yield on five-year treasuries. So not only are stocks performing well on a capital gains basis, they're also cutting bigger income checks than fixed-income investments.
And firms are doing it all with a payout ratio that's around the historic median.
So no, stocks aren't overpriced. They're just not as absurdly dirt-cheap as they were back in 2009.
Too Far, Too Fast
If stocks aren't overpriced, couldn't they still be moving too far, too fast?
Since the market bottomed in March 2009, the S&P 500 has rallied a staggering 160%. That's certainly far, and it's certainly fast, but the new highs in stocks are sustainable.
In fact, making new highs is the stock market's normal mode. Since 1950, 60% of all S&P 500 trading days have been within 10% of an all-time high. And since 1982, 46% of all days were within 5% of an all-time high. Limited to bull markets, those numbers are even higher.
When stocks are in bull mode (as they are now), prices tend to consolidate near the highs. We just managed to forget that over the last five years of playing catch-up in stock prices.
High prices aren't just sustainable, they're where the market's normal mode.
A Rollover in Stock Prices?
December hasn't been kind to stocks, especially considering it's historically a great month for equity performance. But let's put things in context here: The 1.15% correction in stock prices isn't exactly the bloodbath it's been made out to be.
From a technical standpoint, our rally isn't just holding on. It still looks very healthy:
In fact, there's still a long way for the S&P 500 to correct without violating the trend channel it's traded within all year long.
As investors history is the only context we have for where stock prices should be. And while 2013's price action has certainly been impressive, it's also been far from unprecedented. Stocks may "feel" expensive, or too fast-moving, but on a historical basis, they're not.
Does that mean that 25% annual rallies are the new normal? Of course not. But the options aren't limited to massive rally or massive crash either. The last time the S&P broke above the 20% mark in a single year, investors took home 12.78% returns in the year that followed. The time before, we got 8.99% in the follow-up year.
That makes a pretty good case for a strong showing in 2014.
For the reasons I've talked about in the past, I think we're likely to see more sidelined retail money come online in the months ahead. This is still very much a "buy the dips" market.
And so, as long as the uptrend in the S&P chart remains intact, it makes sense to continue doing just that.
-- Written by Jonas Elmerraji in Baltimore.
At the time of publication, author had no positions in stocks mentioned.
Jonas Elmerraji, CMT, is a senior market analyst at Agora Financial in Baltimore and a contributor to TheStreet. Before that, he managed a portfolio of stocks for an investment advisory returned 15% in 2008. He has been featured in Forbes , Investor's Business Daily, and on CNBC.com. Jonas holds a degree in financial economics from UMBC and the Chartered Market Technician designation.
Follow Jonas on Twitter @JonasElmerraji