Market rally is real deal

A steady stream of positive economic and market news last week could be interpreted as a sign that happy days are here again.

While a new stock market high, a reduction in unemployment and proof of healthier household balance sheets all represent signs of progress, the real good news is that this isn’t 2007.

According to a Federal Reserve report released last week, U.S. consumers have spent the past four years reducing debt and repairing their household balance sheets.

The data show that total U.S. household net worth is $66.07 trillion, which is the highest level since 2007. Of that, total financial assets hit a new high at the end of last year of $54.4 trillion, which compares with $52.8 trillion at the peak in 2007.

The unemployment rate, which is still well above the 4.7% mark of 2007, fell last month to a four-year low of 7.7%.

And, of course, there is the new high set by the Dow Jones Industrial Average — surpassing the mark set in October 2007 — which was viewed by some financial advisers as a good reason to re-balance portfolios and take some profits at these new market levels.

Although keeping a portfolio in balance is a crucial part of following any investment plan, pegging portfolio adjustments to the Dow industrials’ latest milestone could be characterized as arbitrary, at best.

REDUCING RISK?

True, the index is up nearly 120% from the March 2009 low, and last week’s eclipsing of the October 2007 high is significant.

But is it a reason to “reduce risk,” as some advisers have suggested? And does moving out of stocks toward bonds even qualify as reducing risk?

“It’s a good opportunity to review portfolios, take some gains and re-balance,” said Jason Burkholder, president of New Legacy Financial Group.

“There is some risk out there,” he said. “Probably the majority of the re-balancing we do will increase our allocation to bonds.”

According to an online survey of InvestmentNews readers last week, more than a quarter of the respondents plan to decrease their allocation to stocks following the Dow industrials’ record, while 14% said they will add to stocks and 60% said they plan no portfolio adjustments.

“The hardest thing to actually do is buy low and sell high,” said Doug Taylor, principal at Taylor Wealth Management LLC. “Right now, people want to let things ride because they’re going great, but things can change tomorrow.”

The Dow industrials have gained more than 9% since the start of the year and are up nearly 12% over the past 12-month period.

Clearly, such a run could push some portfolios out of balance, but what some investors might be missing is a view of the stock market in a macroeconomic context.

“The market is at an all-time high, but it’s not technically overvalued,” said Gene Peroni, senior vice president of equity research at Advisors Asset Management.

“Instead of the kinds of head winds we were facing in October 2007, it seems like the market is now benefiting from tail winds,” he said.

“I can’t remember a time in my career when the Fed has been so transparent about what they’re going to do. I think the Dow could get to 15,000 over the next three to seven months,” Mr. Peroni said.

FEW SIMILARITIES

It is easy and natural to associate the stock market’s level with the carnage that followed last time it was this high. But what is important to keep in mind is that, with the exception of the nominal level of the Dow industrials, there are few similarities between 2007 and the present.

After going through the valley of a major recession, the 10-year Treasury bond, which is admittedly being kept artificially low by Federal Reserve policy, is yielding less than 2%, compared with 4.25% in October 2007.

The rate for a 30-year fixed mortgage during a well-recognized housing market bubble in 2007 was 6.6%, a full 3 percentage points above where it is now.

Even after such a powerful run, the forward price-earnings ratio of the S&P 500 is at 13.9. That compares with 16.1 in 2007.

One of the starkest contrasts between 2007 and the present involves the pattern of investment flows into mutual funds during the period.

Over the past four years, stock mutual funds have had total net outflows of more than $171 billion, while bond funds have had more than $1 trillion in net inflows, according to Morningstar Inc. During the four-year run-up to the market’s peak in October 2007, stock funds had total net inflows of $585 billion, while bond funds had net inflows of $177 billion.

“The economic backdrop is slower now than it was in 2007, but the valuation story is much stronger,” said Philip Tasho, chief investment officer at Tamro Capital Partners LLC. “The more challenging economic environment has muted some of the revenue growth, but corporate balance sheets are now healthier than they have been in a generation.”

The fact that the major market benchmarks are hitting milestones is an added bonus for stocks, because it will help move more individual investors into equities, said Jim Russell, senior equity strategist at U.S. Bank Wealth Management.

“We think there are a lot of things in place that add up to a constructive environment for stocks, and we also like that some of the sentiment remains skeptical, because stocks are one of those things that people just don’t buy on sale,” he said.

Jason Kephart contributed to this story.