Phoebe Venable: Economic Winds Blowing in Right Direction

You may have noticed that the stock market has been hitting new highs a lot lately. In fact, the benchmark S&P 500 index had seven record-closing levels in eight trading days recently. With all the talk about the market at all-time highs, it is only natural that many investors are asking if the market has peaked.

Part of the reason for the recent new high levels on the stock market is solid economic news on the jobs front and further stimulus measures from the European Central Bank. Going back six years to the beginning of the financial crisis, we have endured a long stretch of consistently negative economic news, which got less bad, then periodically positive, to where we are today — which is a slowly improving economy and financially healthy and stable U.S. corporations. Not all of the problems have been solved, and our economy isn't as strong as we would prefer, but in general, things are better and heading in the right direction.

Our economy does not appear threatened by either geopolitical shocks or economic imbalances that have signaled the end of previous bull markets. Barring some shock, an expanding U.S. economy should support further gains in corporate earnings. Corporate earnings are what drives stock prices up, so this bodes well for the stock market's ability to continue its slow grind higher this year. Most valuation models of the stock market no longer show stocks to be "cheap" on average, and this is getting a lot of headline attention. But while valuations are no longer cheap, they are not trading outside of historical ranges and do not appear to be "overvalued" or expensive.

Looking at history to create a lens for the analysis of the current market:

• In 1980, soaring interest rates and weak economic conditions caused stocks to plunge, despite healthy valuations in absolute terms.
• In 2000, interest rate levels weren't particularly high. However, sky-high valuations and a mild economic recession due, in part, to the end of the tech bubble triggered a bear market.
• In 2007, the ensuing recession wasn't caused by interest rates or price-to-earnings ratios, which both looked solid. Rather, the housing bubble and the collapse of Lehman Brothers were the catalyst for the financial crisis.

For investors who have been reading the headlines and thinking they need to sell their stocks, the question is: Where would they invest their funds? The two largest asset classes that investors use are stocks and bonds. Generally speaking, when the economy is improving, stocks perform well and investors increase their allocation to stocks. Investors conclude that the expected returns of the stock market compensate them sufficiently for the systematic risk of the stock market. When the economy isn't doing so well, generally speaking, investors will favor bonds. Today, bond yields are historically low. In fact, the dividend yield of many stocks is higher than U.S. Treasury Bond rates.

While both inflation and interest rates look set to rise at some point, they should remain low enough over the next few years to support rather than undermine equity valuations. Any rise in yields should be gradual and would still have interest rates hovering near historically low levels.

The overall economy continues to improve while headwinds from Washington and unstable financial institutions have diminished. While the rhetoric has grown old, an oversized allocation to the equity market on the heels of improving economic conditions and low interest rates remains warranted despite the headlines.

Phoebe Venable, chartered financial analyst, is president and chief operating officer of CapWealth Advisors LLC. appears each Saturday in The Tennessean.