Considering all the headlines covering Europe's imminent demise, China slowing down, and U.S. unemployment continuing to hover above 8%, one might be confused by the performance of the Dow Jones (INDEX: ^DJI ) and S&P 500 (INDEX: ^GSPC ) over the past few months. They're both within 2% of their highest points this year! Very quietly, the indexes have bounced back from their painful sell-off across May.
^INX data by YCharts.
The situation in Europe
Some definite positives have occurred since Europe faced the specter of a messy Greek exit in May. Greek elections went against the Syriza party, which had threatened to cut off austerity programs, a move that could have resulted in the the Greeks exiting the euro. Then at the end of June, European nations hammered out a deal for a eurowide banking supervisor.
Whether or not investors believe moves like the banking supervisor will be enough to hold the continent together, the larger idea was that action was being taken. That was enough to push markets higher.
However, while the markets have rebounded in June and July, worrying signs remain. One big concern: interest rates remain at dangerous levels. In Spain, 10-year yields hit their highest point in the past year, reaching 7.59% on July 24. Italy's 10-year bonds remain elevated as well, at 5.99%, though they're at least well off from 52-week highs reached last November.
Nowhere for money to go?
If Europe has taken steps to stem its widening crisis, but its most troubled countries remain mired in high-rate environments that threaten to overwhelm their ability to keep funding deficits, why are markets rallying?
Well, where else should investors put their money? After all, the yield on 10-Year U.S. Treasuries is currently 1.54%. Compare that to blue chip stocks, which often pay dividend yields that are far greater. Johnson & Johnson (NYSE: JNJ ) yields 3.5%, while telecoms like AT&T (NYSE: T ) and Verizon (NYSE: VZ ) yield 4.7% and 4.5%, respectively. Both of those companies have been strong performers this year as investors chase higher-yielding stocks in lieu of bonds.
Another widely cited reason for rallying markets is the strength of corporate earnings. That reason for optimism might not be too much a cause for celebration, however. In the second quarter, S&P 500 earnings to date have increased just 0.32% from the year before (according to S&P Capital IQ), an anemic growth rate not seen since 2009.
Better times ahead?
Yet, if you dig into earnings across the S&P 500, some positives emerge. While sectors like energy and materials, which are dependent on global commodity prices, have nosedived, other sectors are holding on much better. Industrials have seen nearly 14% growth since last year, while information technology is up 6% and health care has had a year-over-year gain of 4%.
To be sure, that's below growth rates seen recently, but those sectors are still performing respectably. More to the point, after decades of the market being above its historical P/E level, the market is currently priced near its historical norm at 16 times earnings. That's by no means cheap, but it is the lowest point since the middle of the '90s.
No crystal ball
At the end of the day, investors are in a bit of a pickle in today's market. On one hand, earnings are decelerating and no one knows what to make about Europe's long-term potential. On the other hand, there aren't a lot of attractive options for parking your money outside of stocks. The yield on several great companies far exceeds "safe" debt options.
My end takeaway is the same as it always is: Make sure a large part of your stock portfolio is in great companies built for the long term, the kind that have tremendous brand strength and can weather downturns and come out the other side stronger. If you have a stable portfolio core, it'll help you ride out the ups and down of the market. On the other hand, if you're looking for ideas, you can get a copy of our free report, "3 American Companies Set to Dominate the World," which includes three tremendous companies with great global growth ahead of them. Click here to get your free copy before it's gone.