Eight years ago, investors were more pessimistic than they had been in many decades. Stocks had crashed back to where they stood almost 13 years earlier, banks were failing and comparisons to the Great Depression of the 1930s were routine. It was a great time to buy.

Fast forward to 2017 and the S&P 500 has stormed up 255% from the March 2009 low, money is pouring into shares, confidence is high and stocks expensive. On the model used by legendary British investor Sir John Templeton, the aging bull market is definitely sustained by optimism, and perhaps already becoming euphoric.

For investors this creates a dilemma: chase the returns a final blowout would bring, or switch to cash now to survive the bear market that might follow?

The decision depends on the assessment of the risks and rewards of chasing a shift to euphoria. Bank of America Merrill Lynch recently upgraded its forecast for the S&P 500 at the end of this year to 2450, after the index powered through its previous prediction of 2300. Strategist Dan Suzuki said that valuations look high, but noted the upgrade was driven by increasing investor optimism.

Put another way: The market’s not really worth more, but exuberant buyers will chase shares higher anyway. As veteran strategist Ed Yardeni of Yardeni Research puts it, to make money from here “you’re not making it as an investor, you’re making it as a speculator.”

But today’s market is very different.   Today pretty much everything is expensive, and the valuation of the median stock is much closer to where it was at the turn of the century. Indeed, Doug Ramsey, chief investment officer of the Leuthold Group in Minneapolis, calculates that even with what he calls an “outlandish and probably irresponsible” assumption that median valuations rise to match dot-com levels, the S&P 500 would rise less than 12%.

He’s still invested in stocks, expecting that gains will become more concentrated in popular stocks and sectors as the bull market ages, as happened in past cycles back to the 1920s.

Investors faced with the dilemma of whether to buy an already-expensive market in the hope that it gets even more expensive should examine their own motivations. Shifting to cash looks appealing, but if the market goes up another 20% from here, will you change your mind and buy back in? Another 30%? If so, better to stay invested now than buy in even closer to the top.

Source:  James MacIntosh, Wall Street Journal

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