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Low Rates Driving Market Higher, but Watch Valuations—Searching for Alpha for March 2012

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The stock market has been able to follow a spectacular January with an impressive February. Economists are lauding the domestic economic recovery, along with the improving jobs picture and robust earnings. But make no mistake: lower rates are driving this market higher. 

The Fed’s zero rate policy, which it has said will likely last at least through 2014, has effectively muted any argument for not investing in equities. Low rates will ensure that bank deposits will earn virtually nothing, and higher quality bonds can offer only a bit more. Dividend-paying stocks have become the new fixed income alternative for many investors. This may be great news for stock market aficionados, but beware of the implications.

For starters, doesn’t the recent popularity in large-cap dividend payers sound familiar? Students of the market should recall the “Nifty Fifty” craze in the 1960s and 70s. During that period, large stocks soared in popularity and enjoyed sky-high valuations. The inflation-charged bear market that followed resulted in these stocks underperforming the broader market averages.

There is no evidence that large company stocks are getting overvalued—yet—but advisors should heed the lessons from history.  Sometimes good things come in small packages.


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