Bulls and the bears keep arguing about rally
Wesley Wang's insider trading tale.(Photo: Sam Ward, USA TODAY)
Despite rampant cheering about most major U.S. market indexes having hit new highs, there are still plenty of pessimists who say there is no reason to celebrate.
Doubters point to the economy and geopolitics as chief among the reasons to distrust the market's rally, and Wednesday's drop likely hardens their resolve. The Standard & Poor's 500 index sank almost 17 points to 1554 — pulling back from its record closing high of 1570.25 notched Tuesday — on weaker-than-expected U.S. economic reports and rising tensions with North Korea.
STOCKS: Indexes fall after weak reports on hiring, economy[1]
In one sense, the naysayers are right. The S&P 500's nominal price has finished above its October 2007 closing high. But its current level has not been adjusted for the impact inflation, which over time erodes the value of assets, such as stocks. When adjusted for inflation, the S&P 500's record closing high in 2007 would have been 1750, based on the consumer price index calculated monthly by the Bureau of Labor Statistics. That's 13% above the index's current level.
Bulls, though, say looking at stocks in "real dollar" terms understates the market's positive tone. "Any time you get a new high, there are people who say it's not really a new high," says James Paulsen of Wells Capital Management. "People get angry and try to say it's not really a new high."
To get a handle on how high stocks could rise from current levels, two key ways to look at the market include:
• Including dividends. When the value of dividends are included in shareholder returns, a commonly used calculation, the market's outlook sits squarely in the bulls' corner. Including dividends, the S&P is 150% above its trough — vs. 130% without dividends included — and more than 10% above the 2007 peak, says Howard Silverblatt of S&P Dow Jones Indices. With dividends added in, the S&P 500 has returned 8.9% a year on average since 1989, showing that long-term investors have been rewarded. "The dividends are making a significant difference," Silverblatt says.
• Relative to earnings. Given that stocks have more than doubled from the March 2007 low, skeptics like to say valuations are pushing the limits. But that's just not the case. The S&P 500 is sporting a 16.1 price-earnings ratio based on trailing earnings, well below the 18.8 average annual P-E market ratio since 1988.
The fact that stocks are still reasonably priced is much more important than any dispute over the validity of any new record, says Robert Maltbie of Singular Research. Rather than squabbling over whether the market is at a real new high, investors should be considering whether stocks would be good investments going forward, he says.
"It's not a question of if the new high is something to get excited about, but if the market is too high," he says. "And the answer is 'no.' "