Is the Stock Market Rally Running Out of Gas?


Is the Stock Market Rally Running Out of Gas?

For weeks now, the stock market has been toying with Dow 10,000. Considering
that the large-company index went as low as 6,547 in March, that feels like
cause for celebration. But is it really?

A growing chorus of market-watchers says no. The concern is that the stock
market is overwrought and that down is the only sensible direction to head.
Sure, individual companies have been quick to bounce lower based on bad
news. Both insurance outfits and financial firms lost ground on Tuesday
thanks to two big events — the passage of a health-reform bill by a key Senate
committee and a Goldman Sachs downgrade by an influential banks analyst.

More broadly, though, some strategists are seeing signs that stock values
are inflated and due for a “correction,” that lovely Wall Street euphemism
for falling prices.

One such signal: stocks are about as expensive as they have been in the
long-term, even though the economy remains weak. According to data from
Thomson Reuters, the companies in the S&P 500 index are trading at an
average 15 times expected earnings over the next 12 months. That’s a
completely typical valuation. But this isn’t a completely typical business
environment. If the recovery is slow, and unemployment remains
high — circumstances that seem likely to come to pass — than even a typical
valuation will seem too optimistic.

A more inside-baseball indication of being on shaky ground is the fact that
even on days when stock prices are rising, few people are trading, making
for some fairly thin rallies. “Sellers have entered the market but buyers
have stepped away,” says Mary Ann Bartels, head of U.S. technical and market
analysis at Bank of America/Merrill Lynch. “When that happens, we have to
question the sustainability of the rally.”

Another reason to think higher stock prices aren’t necessarily in the
offing: history. Since the market hit a low in March, it has fairly
consistently marched higher, occasionally falling back, but rarely by more
than a few percentage points at a time. The last time the market has had
such a run without a correction of 10% or more was 1933, says Bartels.
Momentum, pleasant though it may be, tends not to last for such long
stretches.

Of course, figuring out when, exactly, this stretch will end, is an exercise
in future-predicting most investors would be well advised to sit out. Even
the experts are struggling with it. As Sam Stovall, Standard & Poor’s chief
investment strategist, recently wrote: “The U.S. equity market’s advance
continues to befuddle those who are waiting for a sizeable price decline
before putting their money back to work.”

It may be fun to talk about when the market will take its next stumble, but
that’s probably not the main argument a person should use in deciding
whether or not to buy a particular stock.

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