In March 2009, it was easy to say stocks were cheap - the S&P 500, after all, had lost half its value. Fast-forward almost four years, and US stocks have recovered almost all of those losses, and now sit just a stone's throw from a new record.
It might be tempting to suggest it is time for a pullback. Yet, for many investment strategists, the combination of a gradually improved economy, Federal Reserve stimulus, and relatively inexpensive valuations has them predicting further gains - and even talking about the chances of a new bull market.
"The national conversation for four years has been, 'Are you being conservative enough in this high risk world?'" said Jim Paulsen, chief investment officer at Wells Capital Management in Minneapolis. "I think as we go to new highs that is going to change to 'Are you being too conservative in what may be a new bull market?'" It's likely that before long the S&P 500 will surpass its 1,576.09 record, reached October 11, 2007. On Tuesday, it closed at 1,519.43. The Dow is even closer, only about 1 percent away from its all-time record of 14,164.53.
Still, the value of stocks against earnings expectations shows the market is cheaper than in 2007. In addition, the economy appears to be improving rather than peaking, and earnings are much less reliant on what was then a heavily leveraged financial sector. In addition, the Federal Reserve's massive bond-buying programs, designed to keep interest rates low, has boosted the market's value. That raises concerns about what will happen when the Fed says it is ready to begin tightening policy - but that could be some time away as the central bank is targeting a jobless rate of 6.5 percent against 7.9 percent in January.
And, in any case, if the Fed did stop its easy money policies it would be a sign that economic growth was climbing. There is also a wall of money argument in the stock market's favour. The strong surge in prices at the outset of the year, which has driven the Dow up 7 percent, has sucked more money into equity mutual funds in a five-week period than at any time since April 2000, according to Thomson Reuters' Lipper unit. That has been partly fuelled by concerns that bond prices - after climbing in recent years - could retreat. Given low interest rates, investors are also struggling to find attractive yields for bank deposits or in money market funds.
To be sure, that has raised some concerns that there's excessive bullishness in the market, but that alone isn't enough of a reason to derail a rally that is also being fuelled by signs of increased deal making. Mergers and acquisitions in the Americas picked up sharply in the fourth quarter, with about $427 billion in announced deals, compared with about $272 billion in the year-ago period, according to Thomson Reuters data. So far this year, the pace has kept up with deals such as the proposed $24.4 billion buyout of computer maker Dell Inc by Michael Dell and his partner, Silver Lake.
The initial public offerings and secondary offerings markets have also been strong, with 76 companies selling shares in the United States to raise a total of $18.2 billion, the best start of a year since 2008. One of the basic variables investors use to define a stock's value is its forward price-to-earnings ratio, the amount of cash an investor has to pay for every dollar of earnings the company is expected to earn in the next year.
Current data show both forward and trailing price-to-earnings ratios for US companies are lower now than they were in October 2007 by about 11 percent to 13 percent. "The quality and the sustainability of the earnings stream is much higher today and also you're paying less for it because multiples are lower," said Paul Zemsky, head of asset allocation at ING Investment Management in New York. "Much less earnings are coming from finance companies and fewer are coming from leveraged-type companies now," he said.
The financial sector accounted for more than a fifth of the S&P 500 in October 2007 according to Standard & Poor's data, thanks to record-breaking profits from companies like Lehman Brothers that ceased to exist during the financial crisis. Financials now make up 15.7 percent of the index. Something similar happened to technology during the dotcom boom and bust. At the height of the 2000 tech bubble, the sector accounted for 34.5 percent of the S&P - it now accounts for 19.2 percent, still the largest sector.
In October 2007, five of the 10 sectors were above the 10 percent mark and now seven of the 10 make up more than 10 percent each. This more balanced distribution suggests no one sector is overwhelming the average, and that earnings do not depend on bubble-like results from one industry. The economy has rebounded even though the jobless rate remains elevated. The last three months of payroll figures have seen an average of 200,000 in job gains. In addition, industrial output has hit highs last seen in mid-2008 - just before the financial crisis hit.
"If industrial output and the employment numbers continue to improve, this could catch investors by surprise, and spur a new wave of equity investment," said Brad Lipsig, senior portfolio manager at UBS Financial Services Inc in New York. The sluggish recovery has kept the Federal Reserve in crisis mode. Some see the Fed, not market fundamentals, as the strongest pillar behind the four-year rally. They worry the market will react harshly when the Fed starts to remove its accommodative stimulus - which could come as early as next year.
Stocks have done well, in part, because the Fed has underwritten the market's risk, and made stocks look attractive by forcing interest rates lower. If rates rise quickly due to some kind of inflationary shock, it will not help equities. But even if the market surpasses the 1,576 all-time high, it wouldn't effectively be equal to that 2007 peak. When adjusting for inflation, the benchmark would have to scale 1,700 to truly reach new highs. But strategists see a relatively clear path to more gains as retail investors continue to shed their caution. "The emotional journey from panic to jubilance may take much longer than four years," said Lipsig.