Are we ahead of ourselves?

The various stock markets have all rallied massively since their March 9 lows. Some market prognosticators who made similar market bottom calls as I did are now saying that stocks are overvalued and may correct from here. “Correct” means fall back down to fair value. So where do I stand relative to the valuation of stocks in general?

I do not think that stocks, in general, are overvalued. First of all, this kind of aggregate evaluation of stocks is almost always made by comparing the composite price earnings ratio (P/E ratio) of the stock market to some sort of historical P/E, or to an expectation of what the normal P/E ought to be. But we are emerging from a recession where the earnings component of the P/E ratio has been pummeled. As the economy improves earnings will improve lowering the P/E ratio. The stock market is a discounting mechanism. That means that the stock market anticipates the future and generally adjusts immediately to important news. In other words, I think that the market is about fairly valued if one’s earnings time horizon is 12-18 months out.

What that means is that I don’t think that stocks, in general, are a screaming buy any longer. Funny how 45% appreciation will change you from a raging bull to a grazing cow. However, I do feel that there are many individual bargains still to be had, especially among dividend paying stocks. In other words, be careful out there. We need to see more evidence of economic strength and business profits to justify buying, buying, buying. Being picky is always an investment virtue, but even more so given the givens.

Jason