Understanding The Stock Market: Part 2

We thank readers for their emails in response to "Understanding the Stock Market." Predictions of future market prices ranged from a low of 450 on the S&P 500 index to a high of over 3000. Timing for these thresholds ranged widely.

Let’s add more metrics.

For the first input, we thank Torsten Slok, Chief International Economist and Managing Director, Deutsche Bank Securities. The link he sent, below, takes you to a post from NY Fed researchers Fernando Duarte and Carlo Rosa, entitled “Are Stocks Cheap: A Review of the Evidence.” Duarte and Rosa “analyze twenty-nine of the most popular and widely used models to compute the equity risk premium over the last fifty years":

For the second metric we turn to Ned Davis. Ned notes that “Companies hold a near-record $3.8 trillion in cash and short-term instruments.” He cites Dan Sanborn's statement that “Low rates combined with high cash levels have put upward pressure on market multiples.” Ned adjusts the S&P 500 P/E multiple for those heavy cash positions, and that reduces the multiple to 13.1, “which is below the long-term average of 15.4.” Ned concludes that the “multiple may have room to expand further.”

Dealing with stock market valuations in an era of near-zero short-term interest rates is an ongoing challenge. We agree with all the warnings that higher interest rates demand changes in valuation techniques. Of course they do.

But we also see those higher interest rates as a development that will not occur until a long way off in the future. The present policy of central banks is for continued low interest rates. Any economic weakness could take them even lower. It is hard to see higher rates as imminent.

Our stock market accounts remain fully invested in diversified portfolios using ETFs.

BY David R. Kotok,