What’s next for U.S. stocks after all-time high?

As the U.S. markets reach all-time highs, investors are trying to figure out their next move and if stocks are overvalued after the big rally this year.

The Yale Professor, Robert Shiller, who won the 2013 Nobel Prize for predicting the dot-com and housing bubbles, warned investors recently, “don’t expect miracles.”

Currently, Shiller’s cyclically adjusted price-to-earnings ratio (CAPE), which is based on average inflation-adjusted earnings from the previous 10 years, stands at 25, much higher than historical average of 16.

Shiller PE (CAPE). Source: multpl.com

Professor Shiller may be right in his valuation call, but valuation alone has always been a bad market-timing indicator. As we all know, after Federal Reserve Chairman Alan Greenspan made his famous“irrational exuberance” in 1996, stocks continued moving higher and higher for a few more years. In our research, we have found macroeconomic and market technical factors play more important roles in determining short term and medium term market direction, than valuations.

The fundamental and technical factors continue to indicate “risk on,” which favors risk-taking and stock markets around the world.

  • Leading economic indicators and other economic data continue to show positive signs. US ISM Manufacturing Index increased slightly to 56.4 in October and the ECRI Leading Economic Indicator maintained a positive bias. Globally, the Euro zone economies are continuing to recover and the Chinese economy is improving.  In Japan, the super-size monetary stimulus is still in place to continue to bolster the economic recovery.

  • The U.S. equity market continues its global leadership, trading well above its 10-month moving average, a technical indicator. The MSCI World Index also remains in a uptrend. The strong rebound in September and October for emerging markets is a positive indicator for that market.

  • Global central banks continue supporting the equity markets with ultra loose monetary policies.  Prospects of impending U.S. Fed “tapering” are diminished given the views of Fed chairman nominee Janet Yellen and the underlying weak employment picture.

  • Market volatility has been on the decline as investors feel more comfortable with risk-taking, and VIX ticked down a bit in September and October.

Our big picture view is to favor large and small cap U.S. equities, and international developed equities and we are continuing to stay invested in emerging market equities due to their performance recovery in September and October.  Within the U.S. equity arena, we continue to hold positions in cyclical sectors from last month.

The emerging markets continue to show new life that started slowly during August with resurgence from China and South Korea that expanded broadly to other EM countries during September/October. We are fully invested with positions in ten emerging market countries/regions, especially in Asia.

For income-oriented investors, we are fully invested in a well-diversified portfolio of income-generating assets as interest rates are higher than a year earlier. We are fully invested via exchange traded products there, including broad exposures to high dividend stocks, high yield bonds, energy MLPs, emerging market bonds, preferred stocks and bank loans.

The investments discussed are held in client accounts as of October 31, 2013. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable. Past performance is no guarantee of future results.