Dow at 16,000: Sign of a bubble?

With stocks hitting new milestones, is it time to pull back in anticipation that the market will cool? Here are some points to ponder.

By The Fiscal Times Nov 18, 2013 12:33PM

Image: Stock market (© Digital Vision/SuperStock)By Suzanne McGee, The Fiscal Times 

Stocks continue to hit new highs, with the Dow Jones industrials ($INDU) topping 16,000 Monday morning and the Standard & Poor's 500 Index ($INX) briefly hitting 1,800 -- both marks that have never been reached before.

Janet Yellen, the nominee to succeed Ben Bernanke as head of the Federal Reserve, told the Senate Banking Committee last week that the run-up has not reached bubble territory.

"Stock prices have risen pretty robustly," she said. "But I think that if you look at traditional valuation measures, you would not see stock prices in territory that suggests bubble-like conditions."

Based on last Thursday’s closing price, the S&P 500 now trades at 15 times estimated earnings for the next 12 months, the highest such multiple since September 2009, according to FactSet.

“With the forward P/E ratio well above the 5-year and 10-year averages, one could argue that the index may now be overvalued,” John Butters, FactSet’s senior research analyst, wrote Friday. “On the other hand, the current forward 12-month P/E ratio is still well below the 15-year average (16.2).”

With stocks at those heights, is it time to just close up shop for the year right now and sit tight in anticipation that the market will cool? Here are some points to ponder.

Quantitative easing continues to serve as a prop for both stock and bond markets. Remember the selloffs that followed the end to the first two rounds of quantitative easing? Well, we may well have a big shock in store for us when the Fed finally decides to ease off its bond-buying this time around.

Although QE3 isn’t (yet) the longest-lived of the Federal Reserve’s three rounds of quantitative easing (that title still belongs to the 19-month-long first round), if things progress the way Wall Street expects, QE3 will match the length and exceed the size of QE1 in dollar terms.

We can’t expect that the withdrawal of that support -- however gradual -- will be pain free. For more than a year, the Fed’s monthly $85 billion purchases of mortgage-backed securities have kept interest rates at low levels and created additional demand for riskier securities that to some extent has been underpinned by those artificial interest rates.

Until the unwinding begins, we won’t know just how much of this year’s big stock market rally can be attributed to fundamental factors (the prospect of higher corporate profits and revenues) and how much is due to investors chasing stock market returns because the alternatives just aren’t all that appealing.

Even the somewhat stronger jobs data released late last week, however, probably won’t be enough to change the minds of Fed policymakers, and the pundits strongly favor scenarios in which tapering is deferred until next spring.  But for now, this is a great reminder that it’s time to rebalance your portfolio.

Portfolio rebalancing is one of those little tricks that savvy investors use to minimize their risk of underperforming. (Another one is keeping an eye on fees: Above-average fees can turn a market-beating return into something that’s deeply depressing.)

True, just because the market has set a string of record highs doesn’t mean that it’s about to turn turtle. But it does suggest that your allocation to stocks may now be far higher than you had intended -- and gives you a way to force yourself to pocket at least some of those profits by selling down to whatever limit you had previously imposed.

For instance, if you had decided that you wanted 65 percent of your assets invested in stocks, and the rally has taken it to 71 percent, this would be the time to sell until you’re back at 65 percent. Sure, the market may go higher still -- that’s great news for the 65 percent that you’ll still have invested -- but if things go awry for any reason, you won’t have more than you planned at risk.

Instead of worrying about bubbles and trying to time your exit and re-entry into the market, I’d suggest taking a step back and thinking about longer-term issues. Did corporate earnings come in on target? Are the opportunities in the bond market fully priced into yields right now, or are there pockets of value? How comfortable do you feel about the idea of shifting some of your assets into other parts of the global stock market that haven’t kept pace with the S&P 500?

Those topics -- and the investment decisions that flow from them -- will never make into the headlines the same way as Twitter's (TWTR) IPO and the monthly jobs data. But odds are that they’ll be much more significant in shaping your portfolio’s returns and determining your ability to outlive your savings.

More from The Fiscal Times

Nov 18, 2013 3:57PM
I watched Yellen last week shoot the bull with the Senate banking crowd and marveled at what seemed like a lack of concern at this time of any "bubble". When asked about the effects of QE's working down the line to main street she said she felt 100% of Americans should/would/had benefited via 401k's and such. When asked about retired folks who rely on a lifetime of savings and the near 0% return on CD's she really did not address that issue. I guess they are not part of the 100% of Americans who have enjoyed the Fed's generosity.
Nov 18, 2013 1:41PM

""Quantitative easing continues to serve as a prop for both stock and bond markets. Remember the selloffs that followed the end to the first two rounds of quantitative easing? Well, we may well have a big shock in store for us when the Fed finally decides to ease off its bond-buying this time around.""

Pay attention or suffer. I'm prepared.

Nov 18, 2013 3:18PM
Nov 18, 2013 4:19PM
The federal reserve should not be picking who makes money and who loses money. But that's the upside down crazy world they've created. As long as there are tens of thousands of politically connected lazys on wall street who sit around producing nothing of value, wearing ties and gazing into computer screens all day, while skimming loads of money into their pockets from the real work that is done by the working people of the world, this scam will go on.
Nov 18, 2013 4:30PM
The markets have been dettached from reality for awhile now.  If it wasn't for the Fed propping the house of cards up, the dow would be in the range of 10,000- 11,000.  Just look at the financials of the reporting companies.  Over half did not increase revenues, but still made a profit.  The only way to do this is to cut expenses, such as employees or use the latest accounting tricks.  Companies that are not increasing revenue will eventually run out of employees to layoff and tricks to keep making a profit.  Why do you think there are no middle level jobs being created?  The question isn't if the house of cards will fall, it is when.
Nov 18, 2013 3:12PM
Clearly the market experts have no clue what is going to happen in the short term as they have all been wrong for several years straight at this point. 
Nov 18, 2013 1:34PM
At last ... the markets have caught up to where they were before the financial melt down!
Nov 18, 2013 2:47PM

  MOVE ALONG<<<<<<<<<MOVE ALONG,,,,,,,,,,,,,,,,     LOL
Nov 18, 2013 3:59PM

 The Government, the Fed and the 'market' are hopelessly uncoupled from reality, no one seems to care, so why think this is a bubble?
Nov 18, 2013 4:12PM

Just like the speculation with our gasoline supplies. They are the ones who ruin it for everybody.

It's nice to see the market doing something besides losing. Hope it stays on the up swing in the coming months. Way too many lost their shirts so this may help.

Nov 18, 2013 4:54PM

Investors moving into risky vehicles fleeing from CD's is great.  It shows the crowd mentality, but a bubble, NOT.  Only a pin can destroy the "bubble", but there must be a "bubble" to poke.  ITS NOT HERE.  Easy money and confiscation of wealth is the new policy.  Inflation is artificially reported and the Fed will keep it low, by twisting arms.  However, when easy money causes any burst of inflation the run away numbers will only be stopped when everything collapses.  The Fed will print with abandon to prevent such a calamity, but all for naught.  Until then happy money making in stocks with cheap money.  Yellen seems happy now, but wait for all hell to break loose.....everyone will panic.

Nov 18, 2013 5:28PM

[QE 1,2,3,...1,000]  "...created additional demand for riskier securities that to some extent has been underpinned by [the] artificial interest rates"  "... to some extent"?!!  Good grief ... what does it take - someone to walk up and slap you in the face?

Nov 18, 2013 5:17PM

Why would you even suggest a head line like this. The number 16000 does not represent anything but a number.

Why not suggest a bubble at 15500,15575...160025   etc.

Let the markets run instead of always looking for a "bubble" or anything else for that matter that you think could bring the markets down

Nov 18, 2013 4:51PM
It appears the bubble has already been deflated at 3:45 PM.
Nov 18, 2013 2:23PM
The market is getting more injections and is a Yellen !   The final calamity is being setup and you better get ready for the Bitcoin economy.

Tell your Senators to hold up confirming the latest Fed chair nominee (pusher) until there is a Senate vote on AUDIT THE FED.   The financial industry and their Republicrat supporters are pushing this wench hard.  They've got to keep up their dope while you pay for it.

Nov 18, 2013 2:02PM
I may be wrong, but my instinct tells me with all the business that are no longer in existence it leaves a great market share for those that are, hence greater revenue and increased market price. Is it a bubble? Yes, but not an alarming one.  I think it's the new norm until new business are created and take away market share from existing. Just my own opinion.........
Bubble??  Absolutely.  Make sure that you trot out the 'Gloom and Doom' boys to make sure that the market stays shaky.  I'm sure that there's a palm tree somewhere in Tahiti which is possibly leaning the wrong way so we'd better hedge our bets.
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