The overall US stock market is not cheap. But it is not so exuberant that long-term investors need to fear losing money is a given in our opinion. Yes, there are pockets of extreme overvaluation and there are seasonal reasons for being cautious, but the future is unknowable. So we rely on common sense.
We live in a world where investment grade corporate bonds yield only 3%. Yet we continue to find companies, even in the US, with free cash flow yields of 5% to 10%. We therefore believe stocks may continue to offer value on a relative basis if one is selective and patient.
Everyone knows stocks are risky but with yields so paltry safe bonds lack appeal. Simple math implies a 4.8% "current dividend return" for the S&P 500 Index (SPX) if you add up both dividends and share buybacks, according to Deutsche Bank. As a point of reference, the 10-year US Treasury bond yields about 2.6% as of June 19 for investors.In our opinion, the argument for a continuation of the secular bull market is simple. Corporations flush with cash, combined with increased CEO confidence in the economy, means mergers and acquisitions are heating up. Interest rates will probably remain historically low. The psychological zeitgeist is attractive as investors remain shell-shocked from the crashes of 2008-09 and 2000-2002. We are well-aware that long-term metrics are flashing yellow in the US, but markets can stay expensive for an extended period as confidence rises. During the 8-years starting in 1958, the median annual P/E ratio for US stocks was at or higher than current levels. The thesis making the rounds that this bull will end in a bubble, at much higher prices, is a credible one in our mind.
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