Why A Rising Stock Market Isn't Risky

(Note: The author of this fundamental analysis is a financial writer and portfolio manager.)

The S&P 500 Index continues to rise and is likely primed to go much higher, but that does not mean it is becoming riskier, nor does not mean it is becoming more expensive. Still, that didn't stop Barron's from noting that the higher the market climbs, the riskier it gets.

It is only when fundamentals do not support an asset class rise does that asset become riskier. Based on valuation, the stock market enters 2018 no more expensive than when it began 2017. The market's rise will likely continue throughout much of 2018 without interruption as long as earnings continue to grow, along with the U.S. economy, aided by the benefits of the tax reform package. 

Earnings Growth

Valuing the stock market and the S&P 500 is undoubtedly easy to do, because stocks trade at multiples to earnings. And based on current earnings projection for 2018 and 2019, stocks seem reasonably valued.

According to the Dow Jones S&P Indices, the S&P is expected to have operating earnings of $150.57 in 2018, which is up from estimates of $145.80 as of December 29, 2017, as the savings from the new tax reform law trickle in.

But those earnings are expected to increase by nearly 11 percent in 2019 to $166.38, which means the S&P 500 currently trades at 16.8 times 2019 operating earnings estimates. By comparison, when the first quarter of 2017 ended, the S&P 500 was trading at 16.1 times 2018 estimates. 

^SPX Chart

^SPX data by YCharts

Reasonably Valued

It seems that despite the nearly 20 percent gain in 2017, and the more than 5 percent gain so far in 2018, stocks are no more overvalued today then they were a year ago.

And should the stock market follow last year's path, we should continue to see multiple expansion throughout the year. Should 2018 end with the S&P trading at 18.5 times 2019 estimates, a rise of another 10 percent to about 3,100 appears to be in the cards. 

What a Speculative Bubble Looks Like 

Bitcoin is a perfect example of a speculative bubble. The price of bitcoin rocketed from roughly $1,000 at the start of 2017 to nearly $20,000 by year's end on what seemed to be driven by pure emotion. To this day, understanding how to value bitcoin seems a mystery, as its prices have crashed below $11,000 in the early days of 2018. (See also: Bitcoin Price Tanks Over The Weekend.)

To say that the stock market is risky is common sense, but to say that it is risky because it has risen a lot is just flat-out wrong. Should earnings continue to grow as expected and there are no significant geopolitical or global economic meltdowns, then the market will likely continue to climb. We could even make the case that as global growth continues to emerge, this could be just the early days of a multi-year run-up. (See also: 5 Reasons the Bull Market Will Thrive in 2018.)

Michael Kramer is the Founder of Mott Capital Management LLC, a registered investment adviser, and the manager of the company's actively managed, long-only Thematic Growth Portfolio. Kramer typically buys and holds stocks for a duration of three to five years. Click here for Kramer's bio and his portfolio's holdingsInformation presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Past performance is not indicative of future performance.

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