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With the S&P 500 (.SPX) in record territory, millions of investors are feeling exuberant about stocks. But a growing number may also feel the exact opposite — fear that stocks are entering a danger zone.
Certainly, there's enough to worry about. The S&P 500 has now rallied more than 540 trading days without "correcting" by 10% or more, an unusually long winning streak. Stocks look pricey by some measures. And investors fear the Federal Reserve will start tapering its stimulus efforts in coming months — a move that could snuff out the rally, at least temporarily.
Yet while these are valid concerns, many veteran investors point to countervailing forces that could keep the rally going. The best course of action now, these bulls argue: Stick with stocks.
"My clients are fully invested bears," Wall Street strategist Ed Yardeni told investors at a recent conference in Boston. His fear is that stocks will "melt up" too fast. But for now, "the trick to this bull market has been to hang on for dear life. I've been counseling my clients to stay with it," said Yardeni, who's been analyzing the market for more than two decades.
|Value ETFs and funds||Expense ratio||Dividend yield|
|iShares Russell Top 200 Value ETF (IWX)||0.20%||2.1%|
|WisdomTree LargeCap Value ETF (EZY)||0.38%||1.1%|
|PowerShares Dynamic Large Cap Value (PWV)||0.59%||1.8%|
|Dodge & Cox Stock Fund (DODGX)||0.52%||1.3%|
|RidgeWorth Large Cap Value Equity Fund (STVTX)||0.9%||0.9%|
|AllianceBernstein Growth and Income Fund (CBBYX)||0.82%||0.9%|
|Oil refiner stocks||P/E ratio||Dividend yield|
|Valero Energy (VLO)||9.6||2%|
Sources: Thomson Reuters Datastream, Morningstar, Fidelity.com. P/E ratios based on estimated 2014 earnings. Figures as of 11/25/2013.
Here's a brief Q&A to provide some perspective on the market, along with specific ideas about how to invest. As always, you should consult an adviser or do your own research before investing.
Based on traditional price/earnings ratios, the market doesn't look excessively over-valued. The S&P 500 is trading around 19 times trailing earnings. That's above the long-term average P/E of 15.1 but well below the low 30s reached during the tech bubble in 2000.
Granted, some other valuation measures indicate stocks look expensive. And with the bull market in its fifth year the biggest gains may be behind us. Also, a market bubble remains possible unless earnings growth accelerates or stocks correct long enough to let other fundamental factors catch up, according to Jurrien Timmer, co-manager of the Fidelity Global Strategies Fund (FDYSX).
Still, some fund managers see good reasons for the rally to keep going. For one: Fed chairman nominee Janet Yellen said in her confirmation hearings that she doesn't see stocks "in territory that suggests bubble-like conditions." That could be a positive sign for stocks since it means she'll keep favorable monetary policies in place for some time, says John Barr, manager of the Needham Aggressive Growth Fund (NEAGX).
"Yellen pointed out that her goal is to get the economy to full employment," he says. "We're so far away from that, it's unimaginable she'd move away from accommodative policies."
Even if interest rates edge up next year, they'll remain low by historical standards, keeping a lid on borrowing costs and helping corporate profits. Low rates may also continue to push investors into stocks as one of the only places to earn "real" returns above the inflation rate, currently 1%.
With many stocks near record highs, it's hard to argue anything is dirt-cheap. In fact, while the market's average P/E is 19, the median P/E is 34 — meaning half of all stocks trade above that level and half below, according to Barry James, president of James Investment Management in Xenia, Ohio.
A big reason for the disparity is that many large-cap stocks, which carry the most weight in market indexes, trade at below-average multiples. "We're favoring large-caps now," says James. "They have a little greater safety and valuation."
One way to invest: Stick with traditional large-cap "value" ETFs or funds, which emphasize stocks with lower price-to-book or price-to-earnings ratios. These funds may lag the market when growth stocks are in favor. But some academic studies have found that value beats growth over full market cycles.
Large-cap value ETFs to consider include the iShares Russell Top 200 Value ETF (IWX), WisdomTree LargeCap Value ETF (EZY) and PowerShares Dynamic Large Cap Value (PWV). The iShares ETF focuses on the 200 largest companies on the market; the WisdomTree ETF weights stocks according to value criteria and earnings growth; PowerShares uses a range of fundamental factors to weight stocks in the ETF.
Among actively managed funds, some top-ranked choices include Dodge & Cox Stock Fund (DODGX), RidgeWorth Large Cap Value Equity Fund (STVTX) and AllianceBernstein Growth and Income Fund (CBBYX). The funds have all beaten their category averages over the last three and five years and have below-average expense ratios, according to Morningstar.
The downside: Value stocks may underperform growth or the broader market for long stretches. It costs $49.95 to buy the AllianceBernstein fund on the Fidelity platform.
Another area to consider: oil refiners. Their stocks typically do well when crude oil trades at less than $100 a barrel, says fund manager James. Oil is now roughly $94 a barrel, and with growing domestic production putting pressure on oil prices he figures refiners should outperform.
Refiners in his James Balanced: Golden Rainbow Fund (GLRBX) include Valero Energy (VLO), HollyFrontier (HFC) and Tesoro (TSO). All are "really cheap and Wall Street doesn't expect too much from them," he says.
The downside: Oil refiners are highly sensitive to commodity prices and could slump if oil prices spike.
Changing your investment mix in reaction to market trends probably isn't a good idea. Many studies have found that the average investor trails the market due to bad timing decisions: buying high and selling low. A better approach is to establish a long-term investment mix that should help meet your goals and rebalance your portfolio once or twice a year on a regular basis.
Since stocks have surged and bonds have slumped this year that could mean it's time to sell stocks and buy bonds — a tough thing to do these days.
Yet studies indicate that annual rebalancing may add an average 1 percentage point a year to a balanced portfolio, making it worthwhile in the long run. For more investment ideas, see Where to invest $100,000 now.
Daren Fonda is Senior Writer and Investing Columnist with Fidelity Interactive Content Services, a provider of objective investing content on Fidelity.com. He does not own any of the securities mentioned in this article
Before investing, consider the funds' investment objectives, risks, charges, and expenses. Contact Fidelity for a prospectus or, if available, a summary prospectus containing this information. Read it carefully.