The reason why the stock market has continuously defied the skeptics is because they spend far too much time in valuation metrics, which are very poor timing devices.
The fundamentals matter much more, and while it is true that we are not in an economic boom, consider that a good thing, because every boom in the past was followed by a bust. This cycle is Steady Eddie.
In fact, the configuration of 1-per-cent to 2-per-cent core inflation and 2-per-cent to 3-per-cent real GDP growth that we seem to be locked on is historically the real "sweet spot" for the market at any point of the business and market cycle, with an average annual S&P 500 price advance of 14 per cent.
Why make it complicated? Modest growth and low inflation keeps rates low and allows resources to flow into financial assets. It has always been such.
If you want to know the truth (for all you deflationists out there), the S&P 500 actually does infinitely better when core inflation is between 0 per cent and 1 per cent (the S&P 500 is up 13 per cent at an annual rate on average in these periods) than it does when core inflation is above 3 per cent (when the S&P 500 averages around a 9-per-cent annual rate).
And that 2-per-cent-to-3-per-cent, not-too-hot/not-too-cold GDP band is nearly twice as good for equities than when growth zooms ahead at better than, say, a 4 per cent pace (so the growth bulls should be careful what they hope for, too).
But with anything less than 2 per cent growth on a year-over-year basis, the stock market tends to flounder (with bond returns north of 10 per cent, on average).
For the time being, the GDP growth/core inflation mix is still very constructive for the equity market, while typically coinciding with low single-digit returns in the Treasury market.
These bull markets and economic expansions don't simply die of old age – they die of a negative monetary shock, each and every time. There were plenty of folks back in 2003 who said it would be different this time, coming off the tech wreck, capital stock detonation, the destruction of "new economy" thinking, global terrorism on U.S. soil, corporate malfeasance (WorldCom, Enron) and repeated sermons by former Fed chairman Ben Bernanke on deflation, Japan and quantitative easing.
And yet it was not different then, was it?
The stock market went off for a nice five-year rally, doubling over that time span, and did not die of old age when all the chapters of that cyclical book were written.
The bull was gored only after the Fed took the funds rate from 1 per cent (negative in real terms) to 5.25 per cent from the summer of 2004 to the summer of 2006, and if you recall, the real problems occurred following the last rate hike, not the first one – as is typical, cycle after cycle. If history isn't important, why is it mandatory in every school curriculum?
So remember your history – bull phases and business expansions don't ever end until the Fed tightening cycle is over, and this one hasn't even started yet.
So staying in the game sounds very reasonable to me and the risk is actually being out of the market, not in it, especially with cash and equivalents still yielding zero – and government bonds so overextended all it takes these days is a 30 basis point backup in market yields to generate a negative return.