It's Not Too Late to Buy Into the Rising Stock Market

It's Not Too Late to Buy Into the Stock Market's Bull RunThe S&P 500 has nearly doubled from its low of 676 two years ago, and the bull market appears to be just getting its feet off the ground. But as small investors start pulling their cash out of poorly-performing money market funds and pouring their money back into stocks, are the big investors on Wall Street taking their money off the table?

Good news for small investors: The answer is no. Indeed, some of the biggest, such as Laszlo Birinyi and Barton Biggs, are still bullish. And based on valuations, stocks are reasonably valued. For example, the S&P 500 is trading at a P/E ratio of 15.6, far south of the 19.7 typical of bull markets, according to Bloomberg. And then there's the factor of earnings yield: an investment's annual income divided by its price. The gap between the earnings yield on stocks and the yield on 10 year treasury notes is wider than it has been since 1962. At 2.96 percentage points, this gap implies that stocks are quite inexpensive. And while stocks are up 95.6% over the last two years, that's still 36 percentage points shy of the average 131% gain registered during bull markets since 1962.

Companies are in great shape, coming off of record profits in 2010, and earnings are forecast to grow in 2011. In 2010, companies piled up record profits of $1.66 trillion while squirreling away nearly $2 trillion in cash on their balance sheets. At the same time, those companies have been pushing their workers hard -- generating a 2.6% boost in productivity even as unit labor costs fell 1.5% in 2010, according to the Bureau of Labor Statistics. These two factors contributed to the continuation of a decade-long trend: an 8.1% decline in the median family income in America. But S&P earnings are forecast to grow 17% in 2011, according to Bloomberg.

Government Help Pulled Stocks Back From the Brink

The S&P 500's 95.6% rise from its March 9, 2009 low added $28 trillion in market value to those companies, a surge that was heavily supported by $12.8 trillion in U.S. government cash and guarantees, including the $700 billion Troubled Asset Relief Program. (Part of that TARP money, as we all know now, was spent paying $18.4 billion in bonuses to Wall Street after it caused one of the worst financial collapses in history. Which begs the question: Why is America waging a war on teachers after forking over its tax money to pay mammoth bonuses to Wall Street bankers?)

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All the government aid to the rest of the economy also helped support the stock market rebound. For example, the $787 billion stimulus plan put in place in January 2009, $858 billion in tax cuts passed in December 2010, and years of near-zero interest rates coupled with the Fed 's $600 billion quantitative easing program have made things peachy for corporate America. Under President Obama, the S&P 500 has averaged a 26.5% average annual return -- the best in the last 60 years (and far better than George W. Bush's 4.5% average annual loss).

The Fed's policy of keeping rates low has also succeeded in getting people to take more risk in the market. According to the Investment Company Institute, investors have poured $24.2 billion into U.S. stock mutual funds since the beginning of 2011 after pulling $96.7 billion out in 2010. Perhaps in 2010 they were listening to bond maven Bill Gross, who was so wrong when he told me in February 2009 that stocks were a terrible place to be, and wrong again in January 2011 when he was spouting about a new normal of low growth.

Small Investors Rejoin The Party

Nevertheless, small investors are often wrong. In 2007, when stocks were peaking, individual investors added $91 billion to the coffers of stock funds. But the recent investor return to stocks looks more like the beginning of a directional change. For example, one investor interviewed by the Associated Press said she has reallocated more of her investments into stocks, but that higher representation in equities still accounted for just 30% of her portfolio -- down from 80% in 2007.

The question on investors' minds now is whether high oil prices will curb profits -- an oft-quoted statistic lately is that U.S. GDP growth falls 0.5% for every $10 boost in oil prices -- and lead to earnings disappointments. Is that a risk worth taking? If so, how should investors play it?

Take the risk: Oil price increases are likely to be temporary, so you should buy S&P 500 index mutual funds today. If you feel like taking a bit more risk, invest in individual stocks: My favorites are these nine medium-sized technology stocks, companies that are likely to be taken over soon by technology giants searching for growth opportunities.
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