Market needs a correction. But this isn't 1929!February 13, 2014: 1:43 PM ET
The opinions expressed in this commentary are solely those of Paul R. La Monica. Other than Time Warner, the parent of CNNMoney, Abbott Laboratories and AbbVie, La Monica does not own positions in any individual stocks.
Is the stock market "correction" over before it even began?
A market correction technically occurs when a major index like the Dow, S&P 500 or Nasdaq falls 10% from a recent high. At its lowest point of the year, the Dow was 7.5% below its all-time high. That was just a week ago.
But the January jitters and early February freakout are a distant memory. The Dow, S&P 500 and Nasdaq are now all up for the month. The Nasdaq is even in positive territory for the year. And the S&P 500 is just 1.5% from its record.
That's led some experts to wonder if stocks need to have a real correction to shake out some of the froth in the market. But can we please -- for the love of whatever supreme deity or deities you pray to ... and if you're an agnostic or atheist, that's cool too -- stop comparing today's market to 1929?
You may have heard about this chart that's making the rounds among traders and financial media types via e-mail and the Interwebs. It "appears" to show eerie similarities between how stocks have performed lately and how they did leading up to the pre-Great Depression/Stock Market Crash.
I am really reluctant to even bring it up because it looks like a classic case of scaremongering. So if you want more details on the chart, Google it. I've seen better trace jobs from pre-schoolers using an Etch A Sketch.
But I can't deny that people are still talking about it. So let's get this out of the way.
This isn't 1929. Companies are sitting on record amounts of cash on their balance sheet. Profits are growing. And here's the most important thing. While valuations are not cheap, they are not as high as 85 years ago.
Finding an accurate price-to-earnings ratio for historical comparisons is not easy. Most experts choose to look at P/E ratios that are based on earnings estimates as opposed to trailing numbers. Good luck finding reliable estimates for 1930.
Still, there is a widely used valuation metric popularized by Nobel-prize winning economist Robert Shiller. It is known as the Shiller PE ratio and it adjusts earnings for inflation. I found a site that tracks the Shiller PE for the S&P 500 by month. Right now, it's at about 25. In September 1929, it was 32.5.
So stocks have a way to go to get to 1929 heights. And guess what? Even if you still think this is a ridiculously overvalued stock market that's due to crumble, that doesn't have to mean that a depression is nigh.
In fact, using valuations to predict the short-term moves of the broader market is notoriously difficult and unreliable.
The market crash in October 1987 happened even though the Shiller PE was less than 18 just before the drop. And Black Monday ultimately turned out to be a blip in an otherwise amazing bull run and period of economic prosperity that lasted from the mid-1980s to the beginning of 2000.
What's more, the market was trading at a much more insane price-to-earnings ratio at the height of the dot-com bubble than it is now or in 1929. The Shiller PE in December 1999 was 44! Tech stocks subsequently crashed ... and there was a relatively minor economic downturn. The 2001 slowdown was far tamer than the 2008-2009 Great Recession.
And for what it's worth, stocks are still slightly cheaper now than they were the last time the market peaked, back in October 2007. The Shiller PE back then was above 27.
But enough about 1929, 1987, 2000 and 2007. What about today? Has anything really changed in the past week to explain why stocks are once again rallying?
Emerging markets are still a potential trouble spot. The job market in the United States still looks weak ... although it's unclear if it's only due to the weather or a sign of a legitimate slowdown in hiring. The only bit of good news seems to be coming from Washington. (Imagine that!)
Lawmakers agreed to raise the debt ceiling. So a Treasury bond default is off the table for a while. And Janet Yellen confirmed that she is not going to run the Federal Reserve all that differently from Ben Bernanke. But neither of those rank as earth-shattering surprises.
So the volatility may not be completely behind us.
"We didn't have the correction yet," says Bob Phillips, a managing principal at Spectrum Management Group. Phillips thinks that investors may need to worry about how rising interest rates will impact stocks. He notes that the 10-year Treasury yield is inching up again now that it's clear Yellen wants to keep reducing, or tapering, the size of the Fed's monthly bond purchases.
The fact that the Fed is going to buy fewer bonds -- with the hope of completely ending its 2008 crisis-era stimulus programs at some point later this year -- should lead to higher bond rates. Phillips thinks the 10-year yield, currently at around 2.74%, should go above 3% relatively soon.
Phillips is also keeping an eye on gold, which has outperformed stocks so far this year after a horrendous 2013. He said the rebound in gold could be a sign that investors are starting to worry more about the possibility of inflation.
Still, he's optimistic that any pullbacks in the market will be good longer-term buying opportunities. He is not overly concerned that stocks are due for a huge meltdown. He just thinks investors need to have more reasonable expectations.
Wayne Schmidt, chief investment officer at Gradient Investments, agrees.
"There never was a normal pullback in 2013. So it's not surprising that we're overdue for one," he said. "We're not going to get a 30% gain in stocks again like last year. But I still think fundamentals look good across the board."
Schmidt said he's also encouraged by the fact that most of his clients did not panic when stocks were falling in January.
"There was much less concern from individual investors last month. They took it in stride," he said. "People are more calm about the market and have been expecting a pullback."
In other words, the stock market is unlikely to repeat last year's amazing run in 2014. But that doesn't mean it's going to be 1929 all over again either.
Reader Comment of the Week! I am not ashamed to admit that I am a sucker for puns, rhymes and other word shenanigans. So the fact that the new Fed chair has a much easier surname to work with than Bernanke is good news for me. I'm not the only one who's happy.
Indeed. But I am not dwellin' too much on finding other lame rhymes for Janet ... Ms. Yellen if you're nasty. I'm too busy kvellin' about the market's comeback.
Also wondering if the Fed chair, who was featured in a recent Microsoft commercial, could also be a pitchwoman for Dr. Scholl's shoe inserts. Are you gellin' like Yellen? Sorry. I'll stop now. Don Draper, I am not.