NEW YORK – Is it time to cash out of stocks?
The market has nearly tripled in a little over five years, and the Standard & Poor’s 500 index closed above 2,000 for the first time on Tuesday. With each record, the temptation grows to take your winnings and flee.
Plenty of experts think stocks are about to drop. But many others offer compelling arguments for the rally to continue for years.
The bulls point to a strengthening U.S. economy. They also like that companies have plenty of money to keep buying back their own stock, a big force pushing up prices.
The bears argue that, with the Standard and Poor’s 500 index closing above 2,000 on Tuesday, stocks already reflect years of future profit gains. And that forecast is suspect anyway given that so many economies around the world are stumbling. They also worry that U.S. interest rates could rise fast soon, one of the surest ways to kill a rally.
Remember, though, that even the best investors find it nearly impossible to time the market to catch the lows and highs.
The bull and bear cases in detail:
The bull case
• A stronger economy. Four of the past five bull markets have ended with investors selling in a recession, or bailing out because they anticipated one. The odds of a downturn anytime soon? Not very high, at least based on the latest reports and forecasts.
The U.S. economy is expected to grow 1.5 percent this year, then 3.4 percent in 2015, according to Congressional Budget Office estimates. One reason is companies are hiring at the fastest pace in eight years.
More people working means more paychecks and money to spend. And the good news can feed on itself.
All this makes it more likely that companies will keep posting higher earnings.
Analysts expect earnings from companies in the S&P 500 to rise 8 percent this year, then 12 percent in 2015, according to S&P Capital IQ.
• Low interest rates. Interest rates are low, and that’s been great for stocks. They help lower borrowing costs for consumers and businesses. They also hold down interest payments on bonds, making stocks look more attractive by comparison.
Many investors expect the Federal Reserve to start raising short-term rates in the middle of next year. If the Fed keeps the hikes small, the stock market might shrug it off.
• Buyback boom. One of the biggest forces in the stock rally so far is companies buying back their own shares. Companies in the S&P 500 have spent $1.9 trillion on buybacks since the bull market began in March 2009, according to Howard Silverblatt, a senior index analyst at S&P Dow Jones Indices.
By creating more demand for stocks, buybacks have kept prices rising even as others sell. Mutual funds, investment brokers, foreigners and pension funds have been net sellers of stocks over most of the last five years, according to the Fed.
Companies have pulled back sharply from their near-record buying in the first quarter, but their buybacks are still pushing up prices.
The bear case
• Stocks are not cheap. It’s fine to forecast big profit gains well into the future, but what if prices fully reflect expected gains?
That’s what many bears think. They cite the price-earnings ratio, or the price of a stock divided by its earnings per share.
The key here is that low P/Es are considered a better deal. Each dollar you spend on a stock “buys” you many dollars of future earnings. High P/Es buy you fewer future earnings.
The S&P 500 now trades at 15 times what companies are expected to earn over the next 12 months, according to FactSet. That is slightly above the 10-year average of 14.1.
The problem is, P/Es are often not reliable gauges of stock value. .
Many experts believe a better P/E is a “cyclically adjusted” ratio, which averages earnings over 10 years.
It is currently 26. That’s far below the peak of 44 it reached in the late 1990s, but it’s still very high. Since the end of World War II, the average is 18.3.
• Those coming rate hikes. The Fed may be able to raise rates slowly without damaging the economy and stock markets. But its record isn’t entirely reassuring.
Three of the past five bull markets ended after the Fed increased rates.
Inflation doesn’t appear to be a problem right now. But that could change fast if the economy heats up.
• Struggling economies abroad. U.S. companies rely more than ever on foreign economies remaining healthy. Unfortunately, many of those economies are stumbling.