The stock market started the year with a tumble, down more than 10% in early February. Since then, stocks have steadily regained those losses and continued to rise, putting them up slightly since the start of the year.1
Did this sharp rebound make you wonder whether stocks are still good investments? We think they are – the bull market still has legs to run, although it also may stumble regularly. And historically, stocks have provided higher returns than both bonds and cash, but with higher volatility, too.2
Stocks have been rising for more than seven years, making this the second-longest bull market. But reaching new highs and a long-running bull market aren’t good reasons to avoid stocks. That’s because bull markets typically don’t fade away. They tend to end in bubbles or recessions, and we don’t see signs of either at this time.
The stock market looks ahead, which is why it’s volatile when compared to the fundamentals of economic and earnings growth. In our view, those underlying trends continue to be positive for stocks. The economy is still growing at a modest pace, which should support rising stock prices over time. Moreover, if the dollar and oil prices continue to stabilize as we expect, earnings could rebound later this year, providing a catalyst for stocks to rise. Since more than 45% of S&P 500 revenues are generated outside the U.S., we believe the dollar’s modest decline since the beginning of the year can help increase earnings growth for U.S. companies.
While the S&P 500 is no longer inexpensive, we think stocks aren’t overly expensive compared to earnings and interest rates. Historically, the S&P 500 has followed a long-term rising trend, as this chart shows. And it’s still in line with that trend, suggesting it’s not extremely overvalued or undervalued.
Some measures comparing stock prices to earnings and other fundamentals show stock prices rose faster than those fundamentals, as the market anticipated better earnings and growth ahead. For example, the forward price-to-earnings ratio for the S&P 500 is 17.8,1 compared to its 16.6 average since 1990. If the fundamentals improve as we expect, they can keep providing the fuel for stocks to rise further.
Although valuations help when estimating future returns, and valuations that are near average have usually meant average long-term returns, they aren’t good indicators of short-term market moves. Slightly above-average valuations can move even higher (as well as lower). So don’t wait simply because you think stocks are pricey.
And keep in mind that while U.S. large-cap stocks are near record highs, that’s not the case for international stocks, which have lagged and are attractively valued, in our view. In addition, U.S. small-cap stocks (as measured by the Russell 2000) are still down more than 10% from their highs in June 2015. Although they are more volatile, stock returns from small and mid-size companies have been greater than those of large-cap stocks in the past. Consider adding international stocks as well as small and mid-cap stocks to improve the diversification of your portfolio.
While we expect stocks to continue to rise over time, we also expect ups and downs along the way. Higher volatility doesn’t mean the end of the bull market, but it is a reminder to check that you own an appropriate mix of stocks and bonds based on your comfort with risk and your long-term financial goals. Since bond prices tend to move in the opposite direction from stock prices, they can help stabilize the volatility of your portfolio.
Make sure you have enough in cash to cover short-term spending, so you’re not worried about selling if stocks drop. And you may want to consider dollar cost averaging, where you invest a fixed amount monthly. While it doesn’t guarantee a profit or prevent losses, it can help take the emotion out of investing when stocks move.
1 Information as of May 2, 2016.
2 Past performance is not a guarantee of how the market will perform in the future.
Investing in equities involves risks. The value of your shares will fluctuate, and you may lose principal. Special risks are inherent to international investing, including those related to currency fluctuations and foreign political and economic events. Small and mid-company stocks are generally more volatile than large company stocks and may involve higher risks.
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