Is This Market Undervalued, Overly-Complacent ... Or Both?

By Brian Egger of BreakingCall.com

NEW YORK ( TheStreet) -- I was trained to be a value investor and spent a lot of time talking about valuation when I taught securities analysis at Columbia Business School. So there are things that I like about this market. The S&P 500's forward price-to-earnings ratio -- 14.7 times, based on Thomson Reuters consensus estimates -- hovers just above the bottom-third of its historical range. Relative to trailing or forward profits, the earnings yield on the SPDR S&P 500 ( SPY) is 3 or 4 points more generous than the 10-year Treasury bond yield. Those metrics seem pretty bullish.

Smart guys in the blogosphere remain cheerful about the market, even as they acknowledge that its recent gains have been unusually strong. Investment adviser Josh Brown, in a mid-October blog post, entitled "Rocket Fuel," cited several reasons to remain bullish: an averted fiscal cliff; a well-capitalized banking system; a longer lead time before any Federal Reserve Board tapering; and a reprieve from geopolitical tensions.

All of these factors are heartening, but I'm still left with a sense of unease. There are good reasons to be optimistic about the market's trajectory, but it's the unanimity of optimism that bothers me. I feel more at home as a value investor when others are bearish. Actually, it's not only the chorus of optimism that concerns me. It's the casual ease with which potentially bearish indicators have been dispatched.

StockTwits founder Howard Lindzon recently confessed he's bullish, even though he has "a little altitude sickness." He likes the leadership in the market, even as he struggles with the question of how long the market can sustain its strength. "We have been trending up now above the 200 day-moving average since 2007," he writes, while "trying to ride it out until the inevitable decline." I understand his pragmatism, but part of what I hear is, "eat drink and be merry, for tomorrow we die."

Josh Brown argues convincingly that increasing levels of margin debt are just "another bogeyman" to be cast aside. Brown and other writers have pointed out that margin debt, while often seen as bearish, is a concurrent indicator that "always tracks alongside the market's price levels." He links his article to another blog, Philosophical Economics, which puts the case quite simply: "the reason that margin debt is at a record high right now is that the market is at a record high."

What I take away from market watchers like Lindzon and Brown is that there are always reasons to worry. Stocks don't trade above their 200-day moving averages forever, and margin debt levels don't escalate indefinitely. Eventually the market will crack. However, none of these considerations precludes stocks from powering higher in the near term.

They may be right. There's nothing to stop stocks from moving higher. But is that the conclusion of a cynical realist, or an apologist for a bull market that's probably "long in the tooth"? A recent Forbes article, citing Standard & Poors' Chief Investment Strategist, Sam Stovall, took the bullish S&P earnings yield case down a peg, noting that "the current rate environment is artificial ... yield levels are lower than during similar historical periods."

One can argue that the stock market is reasonably, even attractively, valued based on certain valuation metrics. However, should the equity market's earnings yield be considered alluring when it towers above a Treasury bond yield that has been "artificially" compressed by central bankers? That's a question that every self-described value investor will have to contend with during the fleeting months of 2013.

At the time of publication the author had no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.
Brian Egger is the founder, publisher and gaming and travel analyst of BreakingCall.com. During the last twenty years, he has held positions of increasing responsibility as a gaming, lodging and travel analyst at Goldman Sachs, Donaldson Lufkin Jenrette, Credit Suisse, BMO Capital Markets and Topeka Capital Markets. He also served as Associate Director of Research at BMO and Director of Research at the Institutional Research Group. Brian has held four team positions, including two second-place rankings, in Institutional Investor's Gaming, Lodging and Leisure categories. He has also been recognized as a six-time Wall Street Journal "Best on the Street" analyst. Brian taught securities analysis to MBA students as an Adjunct Professor in the Finance department of Columbia Business School. He received a BSE from the Wharton School of the University of Pennsylvania and an MBA from the University of Chicago Booth School of Business.

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