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Is the Stock Market Too High?

Sigma Investment Counselors

September 16, 2014

By most measures, stocks are currently trading at or near all-time highs.  On that basis, one might conclude that stocks are at least high and perhaps too high.  This is looking at the markets in absolute terms.

But what about relative value?  Are stocks high compared to the major alternative investments, cash and/or fixed income?  Again, perhaps, but consider the return on cash, which is currently only slightly more than zero, and, over the long-term, after inflation, is probably negative.

Interest rates on fixed income opportunities are at or near historical lows.  The 10-year treasury bond currently yields approximately 2.5%.  You do have the expectation of certainty.  You are highly likely to receive the designated interest payments on time and full return of the face value of the bonds at maturity.  Whether this will turn out to have beaten inflation remains to be seen.

An investment in common stocks at current prices provides a dividend return of approximately 1.8% (12 months to June 30, 2014 on S&P 500).  Unlike interest payments, dividends tend to fluctuate, but have increased over time.  The ten year dividend return on the S&P 500 is likely to be considerably higher than for the latest 12-month period.  Moreover, from 1926-2013 the return on the S&P 500 has averaged 10.1%.

Equity prices fluctuate and timing an entry point is highly uncertain.  However, average returns from stocks have historically been so much better than alternatives that even over-valued stocks are likely to prove to be a reasonable option over the long term.

Over the next ten years, which do you think will out perform, cash, treasury bonds or common stocks?

All comments and suggestions are welcome.

Walter J. Kirchberger, CFA®

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