NEW YORK — If you’ve stayed out of stocks recently, you might be worried that you’ve missed your chance to get back in. After all, they must be expensive now that the Dow Jones industrial average has reached a record high.
The good news: Stocks still seem a good bet. The bad news: They’re no bargain, at least by some measures.
Many investors obsess about stock prices, but you must give equal weight to a company’s earnings. When earnings rise, stocks become more valuable – and their prices usually rise, too. That seems to be happening now.
Reasons to consider stocks again:
A STRONGER ECONOMY: There are no signs of a recession. Better yet, the economy might be on the verge of faster growth. The Labor Department said Friday that the unemployment rate in February dipped from 7.9 percent to 7.7 percent, its lowest level since December 2008. Employers added more than 200,000 jobs each month from November-February, up from 150,000 in each of the prior three months.
If recent history is any guide, this economic expansion is still young. The previous three expansions lasted 73 months, 120 months and 92 months.
History offers three caveats: First, if you look at the 11 expansions back to World War II, instead of the past three, they last 59 months on average. By that measure, the current expansion is middle-aged, not young.
Second, investing based on U.S. economic expansions might not work as well as in the past. Big U.S. companies generate nearly half their revenue from overseas now, so you need to worry about other economies, too.
Third, earnings forecasts are often too high.
STOCKS REASONABLY PRICED: Investors like to use a gauge called price-earnings ratios in deciding whether to buy or sell. Right now the ratios are neither low nor high, suggesting stocks are reasonably priced. However, another formula suggests stocks are not such a decent deal.
No matter which version you choose, it’s important to think of it as a rough guide at best. Stocks can trade above or below their average P/E’s for years.
OPTIMISTIC INVESTORS: A new love of stocks could prove a powerful force pushing prices up – even if earnings don’t increase. That’s what happened in the five years through 1986. Earnings fell 2 percent, but the S&P 500 almost doubled as small investors who had soured on stocks throughout the 1970s returned to the market.
LOW INTEREST RATES: Interest rates are near record lows. That’s good for stocks because it lowers borrowing costs for companies and makes bonds, which compete with stocks for investor money, less appealing.
If you want to kill a stock rally, boost interest rates.
That’s what happened in the run-up to Black Monday, Oct. 19, 1987. In August that year, the yield on the 30-year Treasury bond rose above 10 percent. Investors thought, “If I could make 10 percent each year for 30 years in bonds, why keep my money in stocks?” So they sold and stocks drifted lower. Then Black Monday struck. The Dow plunged 508 points, or nearly 23 percent — its largest fall in a single day.
Today, the yield on the 30-year Treasury bond is 3.2 percent. The yield on the 10-year Treasury note is 2.05 percent, less than half its 20-year average of 4.7 percent. It could be years before rates even return to that average level.
Of course, interest rates could jump on fears of higher inflation. But inflation has been 1.6 percent the past year, below the Federal Reserve’s 2 percent target. What’s more, the Fed has promised to keep the benchmark rate it controls near zero until unemployment falls to 6.5 percent. Unemployment today is 7.7 percent.