Here's Why the Market Can Keep Going Up

It's been a raucous time for the market lately. Wall Street hasn't just rallied -- it's been fired up, surging, soaring, running, and zooming. Heck, I think it's even bestirred at times.

The S&P 500 is up 60% from the March lows, and many formerly beleaguered stocks such as Citigroup (NYSE:C) and MGM Mirage (NYSE:MGM) have rebounded much further. So the question on everyone's mind is whether the equity soldiers have enough pep to continue their northward march.

And I think the answer is yes ... at least for now.

Choices, choices, choices
The other night I had dinner at a California Pizza Kitchen, and when dessert time rolled around I found myself at a total loss when trying to choose among delicious options like pumpkin cheesecake, red velvet cake, and chocolate banana royale cake.

The problem was that they all sounded really darn tasty. If my options had instead been hot fudge brownie sundae, caramelized shoeleather, and broken glass pie, my decision would have been very easy.

Now hang on, don't run off to grab a slice of pie just yet -- we're still talking investments here.

In a similar way, investors are constantly facing a buffet of choices when it comes to where they stash their hard-earned money. Sometimes there are a number of choices that look promising and it's hard to go wrong. At other times, many options, if not all, can look pretty unappetizing.

The investment buffet du jour
Leaving aside more exotic investments like art and vineyards, most investors are facing a broad allocation choice between equities, fixed-income investments, and cash. Logically, the way most investors are going to judge these options is based on returns, and right now, equities look to be the most attractive.

The current dividend yield of the S&P 500 is 3.4%, and that's a yield investors can collect while simultaneously having the opportunity to see both their principal (the value of the S&P index) and yield grow. And while the forward S&P earnings yield -- which is the inverse of the price-to-earnings ratio -- is of concern to many as stock prices rise, it's currently at 3.9% and would rise to 5.6% in 2010 if Standard & Poor's earnings estimates are on track.

But we can also go under the hood of the S&P index and find individual stocks that have even more attractive yields:

Source: Capital IQ, a Standard & Poor's company.
Earnings yield based on next 12 months' earnings.

And while many of these stats may not stack up particularly well against what equities have historically shown, competition for investment dollars isn't terribly fierce right now. The granddaddy of fixed-income investments -- the U.S. Treasury -- is currently yielding 2.3% for five-year bonds, 3.4% for 10-year, and 4.2% for 30-year. And that's not a yield that we can hope will improve over the near term.

The bond indexes that Lehman Brothers tracks don't offer a whole lot more promise. The global aggregate bond index is currently yielding a flat 3%, while the U.S. aggregate is at 3.6%. Though high-yield bonds offer a more tantalizing 10%, that comes with the risks of highly leveraged companies in a highly leveraged world, and they probably aren't a viable choice for the bulk of most investors' investment dollars.

Cash, meanwhile, offers its services as a hedge and a store of value while investors wait for better opportunities. But cash also comes with the opportunity cost of being a no-yield "investment," and -- and this is true for bonds as well -- investors who stay in cash could find themselves in front of a value-destroying freight train if the U.S. government's easy-money policies turn into significant inflation.

Precious metals like gold are also an option and have been touted by some of my fellow Fools. These shiny metals have "cash-like" properties and are better-positioned to survive the ravages of inflation. If you ask me, though, metals are best used simply as a hedge, since they don't pay out any coupon, and have no sort of income-producing activity backing them.

So it's equities ... for now
I've become increasingly wary about stocks -- particularly when bought as broad indexes -- as prices have continued to charge upward. In fact, the valuation work done by Yale economist Robert Shiller shows that the S&P index is already modestly overvalued based on average S&P earnings over the past 10 years.

But without much in the way of better opportunities, I can't blame investors for continuing to flock to stocks, even at current valuations. We need to be on guard, though, because this math isn't fixed. As stock prices continue to rise and eventually Treasury and other bond yields start moving upward (and they will), there may be good reason to do more exploring outside of the world of equities.

Is there a possible sea change afoot for capitalism? Check out what Fool Jordan DiPietro has to say about the matter.