Is the Market Rally About to Run Out of Gas?

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Traders work on the floor of the New York Stock Exchange in New York City

For weeks, the stock market had been toying with Dow 10,000, and on Wednesday afternoon it hit it. Considering that the large-company index went as low as 6,547 in March, that feels like cause for celebration. But is it really?

A growing chorus of market watchers says no. The concern is that the stock market is overwrought and that down is the only sensible direction to head. Sure, individual companies have been quick to bounce lower based on bad news. Both insurance outfits and financial firms lost ground on Tuesday thanks to two big events — the passage of a health-reform bill by a key Senate committee and a Goldman Sachs downgrade by an influential banks analyst.

More broadly, though, some strategists are seeing signs that stock values are inflated and due for a "correction," that lovely Wall Street euphemism for falling prices.

One such signal: stocks are about as expensive as they have been in the long term, even though the economy remains weak. According to data from Thomson Reuters, the companies in the S&P 500 index are trading at an average 15 times expected earnings over the next 12 months. That's a completely typical valuation. But this isn't a completely typical business environment. If the recovery is slow, and unemployment remains high — and both seem likely — then even a typical valuation will seem too optimistic.

A more inside-baseball indication of being on shaky ground is the fact that even on days when stock prices are rising, few people are trading, making for some fairly thin rallies. "Sellers have entered the market but buyers have stepped away," says Mary Ann Bartels, head of U.S. technical and market analysis at Bank of America/Merrill Lynch. "When that happens, we have to question the sustainability of the rally."

Another reason to think higher stock prices aren't necessarily in the offing: history. Since the market hit a low in March, it has fairly consistently marched higher, occasionally falling back, but rarely by more than a few percentage points at a time. The last time the market has had such a run without a correction of 10% or more was 1933, says Bartels. Momentum, pleasant though it may be, tends not to last for such long stretches.

Of course, figuring out when, exactly, this stretch will end, is an exercise in future-predicting most investors would be well advised to sit out. Even the experts are struggling with it. As Sam Stovall, Standard & Poor's chief investment strategist, recently wrote: "The U.S. equity market's advance continues to befuddle those who are waiting for a sizable price decline before putting their money back to work."

It may be fun to talk about when the market will take its next stumble, but that's probably not the main argument a person should use in deciding whether or not to buy a particular stock.