Rising Stock Prices Flash A Warning.Selloff Ahead?

By Zuckerman, Gregory | The Gazette (Colorado Springs, CO), June 2, 2013 | Go to article overview

Rising Stock Prices Flash A Warning.Selloff Ahead?


Zuckerman, Gregory, The Gazette (Colorado Springs, CO)


It's time to become wary of stock prices.

The market's impressive rally means stocks are at higher levels relative to their earnings than at any time in over three years, while also more expensive based on dividends and other valuation measures--all potential reasons for caution.

It's not yet time to bail on the market. The economy is showing signs of improvement and stocks aren't yet at troublesome levels. But the more extreme valuations go, the greater risk there is for a correction, analysts and investors say.

Even the cost of defending

yourself from a stock downturn

is getting pricey. See this

week's Personal Business

column by Tom Lauricella

That may well have been on the minds of some traders Friday, when the Dow Jones Industrial Average dropped more than 200 points in the month's last afternoon of trading--wiping out the week's earlier gains.

Of course, the market is still up sharply for the year--the Dow having risen 15.35% and the Standard & Poor's 500-stock index climbing 14.34%.

The impressive gains have come despite limp economic growth, continuing worries about the nation's debt load and concern that Europe, China, emerging markets and other foreign economies remain weak.

Investors have set aside these worries to buy stocks, betting that the Federal Reserve will continue to support the market with easy money.

Near-zero interest rates from the Fed, along with its $85 billion a month in bond purchases, have helped encourage investors, many of whom are frustrated with the puny yields available in the bond market and in moneymarket funds, to shift money into stocks.

But that's starting to change, making stocks less attractive on a relative basis. The S&P 500

currently sports a dividend yield of about 2.1%, below the 2.16% yield on 10-year Treasurys. Until recently, stocks carried a higher dividend, encouraging investors to shift to stocks.

Another big reason stocks have done so well: Shares have

been reasonable values, based on a range of metrics, such as earnings and cash flow, even though the market has been rising for over four years, thanks to a robust increase in corporate profits.

Now, the market looks more expensive. The S&P 500 currently trades at 14.4 times its expected earnings over the next year, and 15.8 times profits of the past year, the highest level since May 2010. Earlier this year, stocks traded at lower multiples of 13.5 times expected earnings and less than 15 times earnings over the previous year.

"Valuations are stretched," says Jack Ablin, chief investment officer of BMO Private Bank, who notes that profits are rising but revenues have been essentially flat lately, a potentially troublesome sign.

"Unless investors are anticipating a second-half economic rebound, stock prices will likely be constrained by tepid revenue and earnings growth," Mr. Ablin

says.

A metric favored by Robert Shiller of Yale University that measures stock prices against average corporate earnings of the last decade shows stocks to

be more than 23 times earnings, well above the historical average of 16. …

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