If history is a reasonable indicator of what may lie ahead for stock prices, things look good for further appreciation over the next few years, interrupted, of course, from time to time by events which lead to short term declines. Let's review why things look good.
Still at a Trot, This Bull May Have Farther to Go analyzes the current market's price level in terms of history:
"FOR the last four years, market watchers have bemoaned the muted economic recovery, with its sluggish growth, tepid job creation and continuing investor fears.
“Like a marathoner who didn’t start out at a full sprint, will this bull have more stamina?” asks Sam Stovall, chief equity strategist at S&P Capital IQ. “My belief is this rally could end up lasting longer.”
Bull markets do not typically die of old age, but rather from the side effects of a lengthy rebound, market analysts say. Those include an economy that begins to overheat and a sense of overconfidence that develops among companies, consumers and investors, leading to risky behavior.
At the peak of the average bull market since World War II, gross domestic product was accelerating at an annual rate of 4.2 percent, according to a recent analysis by Mr. Stovall. By contrast, the most recent G.D.P. report found that the domestic economy grew by a mere 0.4 percent annual rate in the fourth quarter of 2012.
Market peaks also tend to show other characteristics: unemployment tends to fall below 5 percent, as companies race to hire; around 60 percent of investors say they are “bullish,” according to sentiment surveys; and the price-to-earnings ratio for the Standard & Poor’s 500-stock index jumps above 18.
Yet today, unemployment — though it has been drifting lower — is still at an uncomfortably high 7.6 percent. Only 38 percent of investors recently surveyed described themselves as bullish, according to the latest poll by the American Association of Individual Investors. And the stock market’s P/E ratio, based on the last 12 months of profits, stands below 16, which is close to the historical average.
“No doubt, circumstances have improved from a year or two ago, but I don’t get a sense that there’s much excess yet,” said James W. Paulsen, chief investment strategist at Wells Capital Management.
There are other signs that “we’re far from the levels of overconfidence that produce the types of excesses that beget a downturn,” Mr. Paulsen added. He noted, for instance, that investors were not overextending themselves by betting on the riskiest segments of the stock market. Household finances are improving. And the ratio of debt payments to disposable personal income is about as low as it has been since the early 1980s. . . .
To be sure, there are some signs that Wall Street firms and Main Street investors are starting to embrace risk-taking again.
For example, although merger-and-acquisition activity among domestic companies is still far off its 2006 highs in dollar terms, the actual number of deals hit a record number last year. . . .
“Yes, you saw some big, splashy deals in M.& A., but I still think we’re in the nascent stages of all of that,” said Mark D. Luschini, chief investment strategist at Janney Montgomery Scott.
As for individual investors, they have started to return to equity funds. Although they yanked a net $281 billion from stock mutual funds in 2011 and 2012, fund investors have poured a net $64 billion into stock portfolios this year through March 20.
Still, market analysts point out that even with these impressive inflows, bond mutual funds continue to pull in more money. “The fact that bond funds still enjoy higher flows than equities is not indicative of a love affair with stocks,” said Duncan W. Richardson, chief equity investment officer at Eaton Vance. “This is far from euphoria — this is just puppy love.”. . .
Historically, interest rate increases by the Fed have been a bull-slayer. But Ben S. Bernanke, the Fed chairman, is on record promising to keep short-term rates low until at least mid-2015. The central bank would need to see a rapidly improving job market or evidence that inflation is spiking before raising rates, market watchers say. . . .
For inflation pressures to start building, wage pressures would have to intensify and factory capacity would have to be stretched. That typically happens only after manufacturing capacity utilization hits 80 percent and the unemployment rate falls below 7 percent, said James T. Swanson, chief investment strategist at MFS.
Right now, capacity utilization is at 78 percent and unemployment is at 7.6 percent. Still, Mr. Swanson said, it’s not inconceivable that at today’s pace of economic growth, the levels he described will be reached by year-end. That would usher in a much different market climate, perhaps one not so hospitable to an aging bull."
Of course, nobody knows what will happen to stock prices in the short run.
Still, both the market's current valuation and outlook are quite favorable over the long haul.
Thus, the best idea for individual investors is to stay the course, remain in stocks and enjoy the ride for the next several years, if not the next few months.
As long as economic growth continues at a moderate pace and inflation and interest rates remain low, then housing will get stronger, jobs will increase and increasing consumer demand will keep the economic indicators improving. That in turn should help stock prices to grow as well.
Things look good for investors willing to take the short term hits and stay the course. The long term direction is up.