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The German share price index DAX board is pictured at the German stock exchange in Frankfurt May 7, 2013. Germany's top stock index hit a record high on Tuesday, the first major European market to top peaks hit before the financial crisis hammered share values.


With major U.S. stock market indexes at record highs and the Dow Jones industrial average this week closing above 15,000 for the first time ever, a natural question arises: Now what? Here are three responses, based on what some observers have been saying in recent days.

1. High-priced stocks point to lower future returns. Sure, this has been a complaint among bearish observers during this latest phase of the bull market, but it has gone mainstream with the arrival of record-highs.

James Hamilton at Econbrowser, who usually discusses economic issues as an economics professor at the University of California, San Diego, weighed in this week by noting that the level of stock market indexes is relatively meaningless without looking at earnings.

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Earnings are at record highs, too, but that doesn't mean they fit well with the Dow above 15,000 or the S&P 500 above 1,600. Like many bull-market skeptics, he compares the S&P 500 with the previous 10-year average of inflation-adjusted earnings – or the Shiller price-to-earnings ratio, which aims to get around inconsistencies in the business cycle and provide a smoothed-out approach to valuations. This approach points to a price-to-earnings ration of 23.4, or well above the historical average of 16.5.

"If the ratio of price to historical earnings is unusually high right now, and if you expect the ratio to revert to more typical values, it suggests that you should expect a lower capital gain on stocks you buy today compared to what you would have earned if you bought at a time when the P/E was at or below its historical average," he said.

So why do forecasters expect stocks to outperform bonds by close to the highest margin of the past 50 years? It's not that they see stocks soaring, but rather they see bonds performing poorly. The yield on the 10-year U.S. Treasury Inflation Protected security is now minus 0.62 per cent annually. As Mr. Hamilton noted, "It's not making too bold a claim that you can find something better than a guaranteed loss (in real terms) each year over the next decade."

2. Bearish investors could capitulate. This is a big hope among bullish observers: Investors who have remained on the sidelines during the bull market will cave in to the pressure – intense with stocks at record highs – and at last throw more money into stocks, driving prices higher as the bull market enters its final phase.

This hope has taken on a new tone now. Josh Brown at the Reformed Broker seems to mock overly bearish investors: "Some people need to reflect back on what they've been doing for the last 8,000 points [in the Dow]. Others need to reconsider whom they've been listening to and what they've been reading all this time. Have their influencers gotten things mostly right or mostly wrong?"

Still, if you've been bearish for the past 8,000 points, I'm not sure how turning bullish now is supposed help. To be fair, though, Mr. Brown isn't suggesting that investors should dive headfirst into stocks. I think he's merely suggesting that making big, stubborn bets on the direction of stocks can sometimes lead to disaster.

3. What goes up, goes up – for a while. The stock market's rise is notable not only for its record heights but also for its remarkably steady rise. The S&P 500 hasn't suffered a decline of more than 5 per cent since November. That's unusual, and it has even defied the expectations of many bullish observers. As noted by Michael Hartnett, chief investment strategist at Bank of America, between 2009 and 2012, there were nine corrections of 10 per cent or more in global equities.

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He now thinks that the risk of a market "melt-up" is high and rising. Stock markets could catch a wave of exuberance that sends them higher – particularly if investors swoop down on undervalued elements.

However, Mr. Hartnett's year-end target on the S&P 500 remains at 1,600, which is 30 points below the index's current level. And he believes that volatility could come back if investors see signs that the economy is performing worse-than-expected, or better.

"The most likely catalyst to provoke volatility and setbacks to risk assets is hot or frigid data that says the economy is breaking out of its range," he said in a note.

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