Even as the stock market has hit multiyear highs recently, stocks still look cheap by many standards. Yet many investors are staying on the sidelines, fearing an imminent end to the three-year-old bull bounce after the market meltdown of 2008 and early 2009. That leaves one key question: Is keeping cash available a smart move or a waste of capital?
The bull argument
A recent article from Bloomberg said that the S&P 500 is almost as cheap as it ever has been compared to bond yields. When you take the S&P 500's earnings and divide it by the current level of the index, you get what's known as an earnings yield. Right now, that yield is 7.1%, and the spread over current 10-year Treasuries is more than 5 percentage points -- its lowest level since the market's bottom in March 2009.
More encouraging for stocks is the fact that companies appear to be starting to funnel more of their cash into capital investment. Having spent years bolstering their balance sheets after finding themselves cash-poor at critical moments during the financial crisis, many companies are finally loosening the purse strings. Now, capital investment is growing at its fastest pace since before the financial crisis. And assuming that the returns on that investment can exceed the 2% or so that Treasuries are earning right now, the benefits should fall through to corporate bottom lines.
Some warning signs
Of course, for every argument, there's a counterargument. One of the biggest, many believe, is that rates in the bond market are artificially low. The Federal Reserve owns more than $1.5 trillion in Treasury notes and bonds on its balance sheet, as well as more than $840 billion more in mortgage-backed securities. That demand is serving to keep rates lower, discouraging saving both among consumers and businesses. When the Fed finally acts to shrink its balance sheet, then rates should naturally rise.
Moreover, on the other hand, earnings have gotten a huge boost in recent years from improvements in productivity and profit margins. Yet with high levels of unemployment, pressure on companies to boost their payrolls could force them to reverse that trend, sacrificing productivity for job gains. That in turn could halt recent earnings growth, pushing earnings yields lower.
Great margins of safety
If you're looking to get money back into the market, cheap valuations for the overall market shouldn't persuade you just to buy an index fund. If you're diligent, you can find even better earnings yields even among blue chip stocks.
For instance, energy companies are priced as though $100 oil will be a fleeting phenomenon. Both Chevron
Technology companies are also presenting some attractive values. Corning
Finally, automakers look cheap. Despite the obvious challenges of a struggling Europe and a slow recovery in the U.S., both Ford
Stocks may look cheaper than ever by some metrics, but that doesn't mean that you can afford to buy just any stock. By looking for even better bargains, you can give yourself a margin of safety that could help prevent big losses in case the current bull run comes to an abrupt end.
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Fool contributor Dan Caplinger rarely looks a gift horse in the mouth. He doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of Corning and Ford. Motley Fool newsletter services have recommended buying shares of Corning, Chevron, General Motors, and Ford, as well as creating a synthetic long position in Ford. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy is of the finest quality.