4 things to consider before investing in stocks
February 06, 2013
Stock market fever is back, and that's always a good reason to worry.
Lately there has been a spate of headlines with titles like, "Is this the beginning of the next great bull market?" and "How to play the melt-up in stocks." The stock market got 2013 off to a strong start with a nice gain in January, and excitement about equities has been building. However, before you rush headlong into the market, here are four things to think about.
1. The market isn't really due for a rally
There seems to be an impression that things have been bad for so long that the market must be overdue for a big gain. The truth is that stocks have already made quite an impressive run. The S&P 500 has risen more than 80 percent in less than four years, so it's not like stocks are trading at bargain-basement prices.
2. Stocks are vulnerable to rising interest rates
From savings account rates to mortgages, CD rates to bond yields, interest rates are at record low levels. Interest rates and stock prices tend to move in opposite directions: When interest rates fall, stocks often rise. This is because a lower interest rate increases the value of the future earnings stream, and also because low interest rates cause investors to look for alternatives. The problem is that interest rates are so low that there is little room for them to fall any farther, and the current level of rates is so unusual that it would be perfectly natural for them to rise.
3. High expectations make disappointments costly
Just look at Apple. The company's stock price got punished recently when earnings failed to meet analyst expectations. Apple's earnings were strong, just not as strong as analysts had hoped. If a stock is trading at a high price because of high expectations, even a slight disappointment can lead to a big fall. Expectations about the stock market in general seem to be soaring, and that just leaves stocks all the more vulnerable to a disappointment.
4. Earnings have been treading water for nearly two years
Stock prices may be up, but there still has not been any recent progress in the thing that actually makes companies more valuable in the long run: earnings growth. In the first quarter of 2011, S&P 500 earnings were at $21.44. Standard & Poors estimates that fourth quarter 2012 earnings will be $21.24. If earnings are going sideways, why should stock prices be going up? Earnings are expected to rise in 2013, so the market may be rallying in anticipation of that. However, until there is tangible evidence that earnings are rising, investors might benefit from a little healthy skepticism.
With CD, savings, and money market rates near zero, and bond yields not much higher, it is understandable that people are looking for alternatives. While that may be driving investors into the stock market, that demand does not make companies fundamentally more valuable -- it just makes them more expensive.
If you are invested for the long term, you should have a substantial allocation to stocks. However, there's no compelling reason why you should pick this particular time to increase that allocation.