Are the recent all-time highs in the stock market justified?
Well, a fair price for anything is the point at which demand and supply meet, so no consummated transaction is theoretically unfair. But that doesn't mean one of the parties can't be making a mistake.
Let's take a look at the economic underpinnings on which the market rests. Some would say the stock market is among the most reliable means of forecasting the future economy, and maybe it is. But I'm not sure that it always is, and I'm not overly impressed by some of the recent economic news.
The lead story from the April 27 Wall Street Journal certainly gives pause: "Economic Growth Stays Soft." A sidebar headline informed us that this "Recovery is Dismal by Historical Standards."
Optimists will nonetheless point to scattered positives, like encouraging U.S. housing trends. The Federal Reserve's most recent Beige Book survey concluded that a strengthening housing outlook contributed to moderate economic growth in late February and March. New-home sales rose 1.5% in March, compared to February's number. But that's not saying much. Sales were actually lower than in January and 40% lower than the 700,000 that most economists consider a healthy pace. And sales of existing homes fell from February to March.
Lenders aren't helping much either, with tighter credit and down payment requirements, despite offering infinitesimal mortgage interest rates.
Other observers are finding hope in the sharp decline in "distressed" home sales, i.e., foreclosures and homes whose owners owe more than the house is worth. But it's essential to remember that there's a multi-year backlog of unprocessed foreclosures that simply haven't yet been sold on the courthouse steps due to political pressure from Washington and some state attorneys general.
But while the delay goes on, so does the problem. Someday, when the political heat has cooled, those properties will find their way to a sheriff's or trustee's sale. When the floodgates open, the new supply will reduce demand and exert downward pressure on home prices.
So if year-over-year general housing trends appear to be improving somewhat, the question is whether they are consistent and sustainable.
And returning to the here and now, it's apparent that any alleged improvement in the economy is largely lost on Main Street, if not Wall Street. More than 75 percent of small businesses surveyed in March expect conditions to be no better, and perhaps worse, six months hence, according to the National Federation of Independent Business.
Members of the Institute for Supply Management reported slower growth in manufacturing (as did a purchasing managers' survey) and services during March. Also for March, the Commerce Department said that durable goods orders fell 5.7 percent from February and that retail sales declined during the month.
And then there was the stunner of April 5, when the Labor Department caught everyone off-guard by reporting that just 88,000 new jobs were created the month before, compared to 268,000 in February.
Finally, the Conference Board's index of leading indicators, a reliable enough set that seeks to reflect conditions three to six months out, fell in March.
Given all of this, are investors beginning to shift their gaze from the ticker to the economic news of the day? Well, if they aren't, they should be. Despite some fits and starts over the past few months, there is no persuasive set of economic numbers that supports a decidedly bullish stock market call at this point.
From this quarter, there is no reason to construe the current raft of unremarkable data as a hearty endorsement for equity investing. In fact, it's now well accepted that the market's recent climb was largely accelerated by the Fed's heavy foot on the easy-money pedal, rather than based on business and economic fundamentals. Now, even some Fed governors can be heard making noise about the end of quantitative easing.
An investor shouldn't ignore all of this. This is a suspect "recovery" to be sure, and it might well be a time when there's simply not much money to be made. Stepping away is better than experiencing a decline in net worth.
Prudent holdings for these times would therefore be found in the fixed-income arena, with funds like Vanguard Short-Term Investment-Grade Bond Fund (VFSTX) or its tax-free companion, VWSTX. There's very little yield (1 to 2 percent) in these, but they beat money-market funds, and the short maturities keep your money reasonably safe. A comparable ETF might be the Vanguard Short-Term Corporate Bond Index (VCSH).
The DoubleLine Total Return Bond Fund (DLTNX) offers more yield - 5.35 percent - and more risk, but you'll have bond stalwart Jeffrey Gundlach navigating the ship when interest rates begin to rise. A comparable ETF is DoubleLine Opportunistic Credit (DBL). And I would recommend my Stable High Yield model at Covestor.com, a portfolio, in which I am personally invested, that seeks to approximate the historical average annual return of the stock market, with lower risk. Since its inception in July 2011, it has an annualized return of over 12.2% and a beta coefficient of 0.27, so it would seem to be achieving its goal to this point in time.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: Disclosure: The author is long VFSTX, VWSTX, DLTNX, and the Stable High Yield model that he manages at Covestor.com. Return for the Stable High Yield model is as of May 1, 2013.