The Market Correction Might Be Tardy, But It Won’t Be Absent

by Richard Band | May 9, 2013 11:00 am

The Market Correction Might Be Tardy, But It Won’t Be Absent

Now that just about everybody has given up on it, will we finally get a stock market pullback worthy of the name?

Fooling the majority is what Mr. Market loves to do, so I wouldn’t put it past him. I recommend staying one step ahead of him by taking the opportunity to capture your profits … as long as the rally has altered your stock allocation significantly, that is.

I’ll be the first to admit that, at the moment, it’s pretty difficult to find a good reason to sell stocks. The Federal Reserve’s ultra-aggressive monetary policy has steamrollered the many fundamental factors that might normally have tripped up the market by now: downbeat earnings guidance by U.S. companies, recession in Europe, slowdown in China and saber-rattling in the Mideast, to name a few.

The fact remains, however, that the straight-up rally since late December has left domestic equities richly valued indeed. One of my favorite long-term value gauges is the price-sales ratio of the S&P 500 (the index divided by the sales per share of the firms comprising the S&P). Sales can’t be manipulated with nearly so much ease as profits, so the price-sales ratio provides a useful tool for comparing stock market valuations over time.

The price-to-sales ratio for the S&P 500 stands at 1.49 — roughly 57% above its average for the period from 1955 to the present. In fact, before 1997, when Wall Street’s Internet frenzy was already well advanced, the index had never fetched such a high P/S ratio as it does today.

Of course, overvalued markets can become even more overvalued. The S&P still is much cheaper than it was at the manic top in March 2000. When prices get as stretched on the upside as they are now, though, the risk that something could go wrong rises dramatically.

This is no time to abandon a disciplined approach to investing. If you’re overexposed to stocks (in this environment, I’d say a conservative investor should have no more than a 50% portfolio weighting in stocks), use today’s lofty prices as an opportunity to cut back.

If you’re underweighted in equities and looking for a chance to build up your holdings, do it gradually, over a period of three to six months.

Richard Band’s Profitable Investing[1] advisory service helps retirement savers outperform the market without losing a minute of sleep along the way. His straightforward style and low-risk value approach has won seven Best Financial Advisory awards from the Newsletter and Electronic Publishers Foundation.

Endnotes:
  1. Profitable Investing: http://profitableinvesting.investorplace.com/

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