There have been a litany of articles written recently discussing how the stock market is set for a continued bull rally. The are some primary points that are common threads among each of these articles which are: 1) interest rates are low, 2) corporate profitability is high, and; 3) the Fed’s monetary programs continue to put a floor under stocks. The problem is that while I do not disagree with any of those points – they are all artificially influenced by outside factors. Interest rates are low because of the Federal Reserve’s actions, corporate profitability is high due to accounting rule changes following the financial crisis and the Fed’s liquidity program artificially inflates stock prices.
However, while the promise of a continued bull market is very enticing it is important to remember, as investors, that we have only one job:  “Buy Low/Sell High.” It is a simple rule that is more often than not forgotten as “greed” replaces “logic.” However, it is also that simple emotion of greed that tends to lead to devastating losses. Therefore, if your portfolio, and ultimately your retirement, is dependent upon the thesis of a continued bull market you should at least consider the following charts.
It is often stated that valuations are still cheap. The chart below shows Dr. Robert Shiller’s cyclically adjusted P/E ratio. The problem is that current valuations only appear cheap when compared to the peak in 2000. In order to put valuations into perspective I have capped P/E’s at 25x trailing earnings as this has been the level where secular bull markets have previously ended. I have noted the peak valuations in periods that have exceeded that level.
The next chart is Tobin’s Q Ratio. James Tobin of Yale University, Nobel laureate in economics, hypothesized that the combined market value of all the companies on the stock market should be about equal to their replacement costs. The Q ratio is calculated as the market value of a company divided by the replacement value of the firm’s assets. With the exception of the “tech bubble” we are near the peak of every major bull market in history.
