TINA is the driving force behind the Dow Jones Industrial Average, which saw new highs this past month before retreating, says Nathan Klitzing, principal at Cambridge Capital Management in O’Fallon, Ill.
“Right now,” said Klitzing, “there’s an acronym that’s thrown around, TINA. TINA stands for There Is No Alternative to stocks. Anything fixed income — CDs, government bonds, corporate bonds and municipal bonds — is historically low in rate of return.”
For example, the yield on a 10-year U.S. Treasury bond is just 2.5 percent compared to an earnings yield on the Standard and Poor’s 500 index of 5.2 percent — more than double the return on the T-bill. Historically, according to Klitzing, the differential between the two is more in the neighborhood of 1.6 percent.
“That tells us that markets aren’t as overvalued as what the straight profit-to-earnings multiple suggests because it’s comparing it to other alternatives,” Klitzing said. “I think you’re remiss to talk about multiples without talking about other alternatives and interest rates because they play a big part in the overall pricing of financial assets right now.”
That lack of attractive alternatives drives investment to the stock market and that bids stock prices higher. But, Klitzing says, stock prices are not greatly out of line with historical averages.
“Analysts generally use S&P 500 Index as a barometer because it’s a little bit more robust than the 30 stocks in the Dow,” Klitzing said. “Looking at the price-to-earnings multiples over the last 12 months you see that the price divided by earnings is about 18.8. Historically, going back to 1870, the market average is about 15 so that would tell you we might be a little over-extended just looking at the past 12 months.”
Another barometer to measure stock prices, according to Klitzing, is the price-to-earnings ratio going forward, basing it not on what a company did over the last 12 months but what it is expected to do over the next 12 months. When you look at current stock prices through that lens, he said, you see that the forward multiple is about 16.5 whereas the mean over the last 30 years has been in the 13 to 15 range.
“That would also tell us,” Klitzing said, “that, from a multiple standpoint, markets might be — if not stretched — definitely not cheap.”
Woody Gray, senior vice president with Gray Group Wealth Management in Swansea, agrees that stock prices, in general, are fairly close to historical averages.
“One would have to take each security on its own merit,” Gray said, “but Bank of America/Merrill Lynch Global Research shows in general we are closer to fair value than overvalued.”
Underlying the low interest rate environment is the Quantitative Easing program of the U.S. Federal Reserve Bank. Quantitative Easing is an unconventional monetary policy, Gray said, in which the Federal Reserve Bank has been purchasing government securities or other securities from the market in order to lower interest rates and increase the money supply. The effect has been to keep interest rates on fixed-rate investments very low for a long period of time.
“Some people say what’s going on right now with the Federal Reserve is financial persecution on retirees,” said Klitzing. “You have thousands of baby boomers retiring every day and they’re looking at their investment alternatives. It’s very difficult to keep up with the cost of inflation when you’re getting a half a percent on an 18-month or 24-month CD.”
But Fed Chair Janet Yellen has been putting the brakes on the QE program and that should result in higher interest rates.
“Conventional wisdom says that we should not forget that what goes down will eventually come back up,” Gray said. “Rates will begin to rise as our economy rebounds and according to BofA/Merrill Lynch Global Research reports, the Federal Reserve guidance seems to indicate that as quantitative easing unwinds we should be anticipating rising interest rates. The question is likely not if, but when? Thus the concern for both short- and long-term fixed-income investors is not to be caught unprepared. Therefore, now is the time to begin preparing for this shift in the interest rate environment. Investors should seek professional advice from a qualified financial adviser.”
Larry Lexow, owner of Lexow Financial Group in Edwardsville, offered a different view on overall stock prices. He said that investors are looking at the balance sheets of companies and finding them sitting on lots of cash. That, he says, provides a picture of a solid company that will be in the position to invest and expand without the need for debt when the time is right.
“Companies have a lot of cash that they are not putting into investment or expansion right now,” Lexow said. “Part of the reluctance to invest is the uncertainty created by Obamacare. I’m still hearing a lot of companies that do not have a good handle on what their health care costs are going to be going forward. They’re not investing in future growth but I think at some point that will change. As it does, we believe the market will continue to go up.”
While TINA has been driving stock prices up, Klitzing said that he does not see a bubble forming. He said that P/E ratios on some stocks in the late 1990s were double historical averages. And, he suggested, the stock market crash of 2008 is playing a role.
“I think if anything the scars of 2008 are putting a bit of a ceiling on these multiple expansions that you would otherwise see,” Klitzing said. “When you see the largest financial collapse since the Great Depression, those scars take generations to heal. Normally, in the fifth year of a bull market you would hear people asking where they should invest next. Instead, we’re hearing from people, ‘How can we keep our money safe?’”
Klitzing said not to expect the kind of stock market growth we’ve seen over the last five years.
“For our clients we’ve lowered our projected rate of return,” he said. “TINA’s still in play but don’t lose track of the Federal Reserve because that will have a lot to do with what will happen with markets going forward.”