‘Stocks are expensive.’

‘Valuations are stretched.’

‘Wall Street is heading for a fall.’

We’ve heard these comments non-stop.

Not just over the past week, but for the past year or more.

Even the US Federal Reserve is blowing hot air about stock values.

And yet, what has happened?

That’s right, stocks have continued to rise. And so far, contrary to what the crash predictors say, stocks continue to justify these so-called high valuations…

One of the big things we heard coming into the US earnings season was that stocks would struggle to match analysts’ estimates.

Well, tell that to the three-quarters of US stocks that have beaten estimates.

As Bloomberg reports:

‘About 77 percent of the 82 companies in the S&P 500 that have posted results this earnings season beat analysts’ profit projections, and 70 percent exceeded sales estimates… Profit by the gauge’s members increased 6.2 percent in the second quarter, and revenue rose 3.3 percent…’

That’s pretty good.

And it’s a good sign when companies can increase revenue and profits. It tells you that companies have some pricing power.

Which statistics do you believe?

That would seem to tie in with the improving US jobs market. The US unemployment rate is now down to 6.1%. Not everyone is convinced that the jobs numbers are going in the right direction.

However, the Shadow Government Statistics website claims that, rather than improving, the US job market has actually gotten worse.

It now figures that around 23% of working age Americans are now out of work.

Can that really be true? It seems to be an impossibly high number…almost 1 in 4 out of work. That’s not saying that we necessarily believe the government’s statistics.

In fact, we’ll openly say that we doubt the accuracy of all government stats.

Call us naïve if you like. But we just don’t buy the idea that the US unemployment rate is worse today than it was in 2010.

But what the heck. We could spend hours, days, weeks, months, or even years arguing the toss about whether the unemployment rate should be 6.1%, 23% or somewhere in between.

But we won’t do that. Why? Because we can safely say that trying the figure the ins and outs of the unemployment rate is unlikely to make an investor a single dollar of profit on stocks…or any other investment.

That’s why for longer than we care to mention, we’ve advised investors to put macroeconomic events on the backburner. There’s a simple reason for that.

And it’s all to do with interest rates.

Only one thing is moving stock prices now

Everything ties into interest rates.

It’s the only thing that matters in the economy at the moment.

If investors think interest rates will rise, they’ll sell stocks. That’s because higher interest rates are typically bad news for companies that have debt (in other words, almost every company).

On the other hand, if investors think interest rates will fall or stay the same, they’ll buy stocks. That’s because lower interest rates are generally good news for companies with debt.

The flipside is that lower interest rates are bad for bank account savers. But it means that investors may get out of cash and buy stocks in order to chase higher returns to compensate for the lower interest rates.

That’s exactly why we favour holding shares.

As long as companies can keep growing sales and profits, investors won’t ditch shares in a hurry. And even if investors don’t expect rapid growth and share gains, they’ll still have to consider the alternative before they sell.

Do they want to keep earning — say — a 5% dividend yield with the potential for income and capital growth? Or do they want to stick cash in a bank account and earn less than that, without the chance of income or capital growth?

To our way of thinking, it’s a no brainer.

But that doesn’t mean investors should become complacent.

It’s still a buyers’ market

Despite your editor’s bullish view on stocks, we understand that there are risks.

One day, one of the fake crises we’ve written about will turn into a real crisis, and it will knock stocks down.

But that isn’t about to happen yet. Besides, you can tell it’s a pretty good market because the hedge funds are getting grumpy about their poor returns.

As the Financial Times reports:

‘Hedge fund managers expect to deliver some of their worst returns since the financial crisis this year, amid rising concerns over stretched equity market valuations and signs of rising geopolitical tension.’

There you go. There’s that phrase again: ‘stretched equity market valuations’.

According to the report, ‘Nearly two-thirds of hedge fund managers are anticipating full year returns of 6 per cent or less…’

So far this year, hedge funds have posted gains on average of 3.2%.

That’s not great, seeing as the US S&P 500 index is up 7.5% year-to-date.

But it suggests that despite the gloomy outlook by hedge funds they at least expect the rally to continue through the rest of this year…unless of course, the hedge funds are betting big on a crash!

That’s the thing. Hedge funds love market volatility. It means they can make all sorts of complicated bets using derivatives markets. But that kind of volatility isn’t always useful for the regular investor.

As an investor you prefer to see calm markets, because there are fewer opportunities for regular investors to profit from volatility.

There is of course one way you can profit from volatility — that’s by taking advantage of short-term price drops to buy stocks on the cheap.

This is another reason why we suggest investors have a healthy cash balance. It gives you the opportunity to buy into the market from time to time when stocks take a beating.

You’ve seen that in recent months with Aussie stocks. The market has traded in a 200-point range since February. It’s at the top of that 200-point range now. At some point the market will break out higher. Has the market reached that point now?

Perhaps. And remember, just because the market is heading higher, it doesn’t always mean the market will fall. In fact, historically, new highs tend to lead to higher highs. That’s why stock prices have a strong history of rising over time.

This remains a buyers’ market.

Cheers,

Kris+