Is it too late to chase the stock market rally?

NEW YORK Wed Mar 6, 2013 6:35pm EST

A combination photograph shows (top) a general view of the main trading floor of the New York Stock Exchange during the closing moments of the trading session in this February 27, 2007 file photo; and (bottom) the same vantage point ahead of the closing moments about on March 5, 2013. REUTERS/Mike Segar (top), Brendan McDermid

A combination photograph shows (top) a general view of the main trading floor of the New York Stock Exchange during the closing moments of the trading session in this February 27, 2007 file photo; and (bottom) the same vantage point ahead of the closing moments about on March 5, 2013.

Credit: Reuters/Mike Segar (top), Brendan McDermid

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NEW YORK (Reuters) - As soon as the Dow Jones Industrial Average hit another all-time high (of sorts) on Tuesday, Kentucky-based financial adviser Billy Lanter began fielding phone calls from eager clients.

One conversation in particular made him pause.

A client, whom Lanter describes as a conservative investor, declared himself ready to increase his allocation to stocks.

Make no mistake: Lanter is quite bullish. But, he said, "it's always a concern when our nervous Nellies come out of the woodwork" and start getting excited about stocks.

Harnessing America's newfound enthusiasm with stocks is creating a dilemma for many money managers and financial advisers. And it's an ironic one, considering they've spent the past three years trying, often unsuccessfully, to coax anxious clients back to equities.

On a relative basis, stocks still look cheap compared with low-yielding bonds. Yet the nearly 9 percent rally in the Dow since the start of the year and renewed investor enthusiasm suggest that the market is getting closer to a peak.

The broader Standard & Poor's 500 index, the benchmark for most U.S. mutual funds, is less than 1.6 below its nominal all-time high of 1,565. Once inflation is taken into account, both indices remain several percentage points below their highs.

Stocks have rallied for several reasons, of course. Home prices in the United States are recovering, American auto sales are at five-year highs, and central banks keep taking extraordinary steps to support the global economy. Investors who have sat out the rally so far may wonder whether they're coming too late.

Here are the bullish and bearish cases for investing new money in the stock market with the Dow near 14,300.

IF YOU ARE A BULL

Even with its gains, the stock market continues to look better than other alternatives, some money managers and strategists say.

"In absolute terms, the stock market is at fair value, but relative to bonds and cash the stock market is still cheap," said David Kelly, chief global strategist at JP Morgan Funds. That's because the S&P 500 trades at a forward price-to-earnings ratio of approximately 14, well in line with historical norms.

Kelly points to several factors that could continue to push stocks higher despite the already-strong rally. Rising home prices are helping middle class Americans feel stronger about their financial situation, and there have been few signs that higher payroll taxes or cuts in government spending have had a significant impact on the economy, he said. Corporate earnings, meanwhile, grew by about 6 percent over the last quarter, even as analysts worried that earnings might stall.

In part from the momentum of retail investors returning to the stock market after pulling nearly $400 billion from stock mutual funds between June 2008 and December 2012, the stock market should return about 7 percent per year over the next five years, according to Kelly's forecast. Financial stocks could outperform the broad market during that time because they remain cheap as companies deal with increased regulation.

Value stocks, which are often mature businesses that pay dividends and have low price-to-book ratios, may continue to outperform the broad market through the end of this year, too, said James Lauder, co-manager of the Wells Fargo Advantage Target-Date Funds, which have a total of $13.8 billion in assets under management.

"We don't see anything that suggests that a big correction is coming," Lauder said.

Investors ready to take the plunge could opt for the $125 million SPDR S&P 500 Value ETF, which screens for companies based on factors such as book value and price-to-earnings ratio. The fund, which costs 20 cents per $100 invested, has its largest positions in General Electric, Chevron and AT&T, and has returned 15.2 percent over the last year.

Lanter, an investment advisor at Unified Trust in Lexington, Kentucky, which has approximately $3 billion in assets under management, has increased his stake in both large-cap value stocks and European equities.

He has been adding to his position in the $10.4 billion SPDR S&P Dividend ETF, which holds the 60 highest-yielding stocks of the S&P 1500 that have a track record of raising their dividends annually over the last 25 years. The fund, which costs 35 cents per $100 invested, yields 3 percent and is up 14.8 percent over the last year.

"While I wouldn't be surprised at some stock price consolidation in the short-term, we don't think the market is overpriced," Lanter said.

IF YOU ARE A BEAR

Market history suggests that any new highs will be short-lived, said Sam Stovall, chief equity strategist at S&P Capital IQ.

Since World War II, the S&P 500 has tended to gain an additional 3 percent after breaking through a past high before falling meaningfully, according to Stovall. The majority of those stumbles came within two months of hitting a high, and were of 7 percent or less.

David Wright, co-manager of the $805 million Sierra Core Retirement fund, sees a market downturn lasting until the job market recovers to its prior peak. As a result, he has recently moved all of his fund's assets out of U.S. equities. Instead, he's been adding to his position in the dollar index and European high-grade corporate bonds.

"It's hard to believe that there is any upside left," Wright said. "The market has fully realized every last drop of fundamental value in equities."

(Reporting By David Randall. Editing by Lauren Young and David Gregorio)

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