IRA Investing: Don't Sell IRA Stocks at New Highs

I have the distinct impression that these investors are currently looking at new market highs as a reason to be cautious because the market just can't continue to go up forever. This sentiment leads me to continue a bullish stance in my IRA.

If things were to change, and these same investors started to buy into the bull market in a big way by reducing their short positions and buying more aggressively, I would probably reverse myself. But that hasn't happened yet.

The second indicator is valuation.

Is the market substantially overvalued? I'm not an economist, and I don't attempt to forecast corporate earnings, but looking at market valuation currently, the market doesn't seem expensive.

One way I like to look at valuation is to compare bond yields with stock yields at the current time. The stock yield I am referring to here, though, is actually an earnings yield (the inverse of the P/E ratio, so a P/E of 20 equals an earnings yield of 5%).

Barron's has been publishing this statistic for many years, and it shows the ratio of high-grade corporate bond yields to the earnings yield of the Barron's 50 stock average.

Lets look at a chart of this statistic now.

This is a five-year chart of the S&P 500 in black and the bond yield/stock yield ratio in red. As a general rule, when the yield on bonds approaches twice that of the earnings yield on stocks, caution is warranted.

For example, if bond yields were to creep up to 8% and the earnings yield on stocks dropped to 4% (indicating a current P/E of about 25 times earnings), we could say that valuation was quite high.

On the positive side, when bond yields are about equal to stock earnings yields, valuation seems very low.

That is the current situation:

BOND YLD/STK EARNINGS YLD VS. S&P 500

Click here for larger image.

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