Height Fright

As the Dow again threatens 14,000, brace for another round of headlines squawking "All-time highs! The end is nigh!" At MarketMinder, we cannot too strenuously encourage you to now and forever, world without end, ignore the Dow and other price-weighted indexes—they are misleading and broken. But the S&P's capitalization weighted, and it's hitting new highs too. Scary!

But what's so scary about 1550? Or 1600? Or S&P 2000? What makes a price level indicative of coming disaster? Was the market "too high" when it hit 369 in 1990? What about 120 in 1973? Of course not—the market's price level moved considerably higher (and don't forget total return—dividends are a huge part of market return) from previous "high" points.

Investor fear of heights is nothing new—we learned it from our ancestors. Millennia ago, our ancestors figured out pretty darn quick falling off a cliff was to be avoided—the outcome was usually fairly gruesome. This is why investors typically fear anything in a heights-framework. A great example is investor fear of high "P/Es"—they think high P/Es mean prices are too "high" and have a long, gruesome way to fall. The fear persists, despite ample historic evidence proving P/Es, high or low, aren't indicative of future return or risk. The fear of heights simply overpowers rationality.

Just as it does when headlines scream "Markets Hit New Highs!" Yet, markets hit new highs all the time in bull markets, and keep rising for months, nay, years even, well-eclipsing past records. If there's a magical price level beyond which markets may not rise, we've yet to see it (but we suspect it's being guarded by leprechauns and a unicorn). And, as we detailed in "Run Bull! Run" (June 4, 2007) there's no predetermined length after which a bull market must end.

Note too, media stories about market peaks always fail to account for inflation. Prices are 20% higher now than at the market's previous peak—the S&P would need to hit 1860 to hit an inflation-adjusted high. What about earnings? Globally, they're 80% higher—should we account for them and not panic until S&P hits 2800? Maybe not, because if the market were selling at the same P/E as the previous peak, the S&P would be at 2600. All meaningless price levels to fear.

In life, acrophobia is a pretty healthy thing—it's your brain telling you, "Hey! Major fall potential here! Big ouchies!" But in investing, it makes you focus on arbitrary, meaningless indicators. The market will be high enough when the fundamentals driving the bull dry up and some major negative develops against a backdrop of broadly euphoric sentiment. We don't see that right now—all we see are baseless fears and a rush to find culprits for imaginary market weakness (e.g., subprime and housing bubbles). This bull is running on a historically unique earnings yield-bond yield gap driving an epic wave of supply destruction through cash-based M&A and buybacks. Earnings are strong and the global economy is healthier than most acknowledge. Enjoy the view—the market isn't "too high"—it's not high enough.