THE BLOG
06/18/2014 01:25 EDT | Updated 08/18/2014 05:59 EDT

Stock Market Highs: What to Watch Out For

Beyond the goofy hype and hyperbole, the silly alliteration and the abundant capital letters, headlines like "Market's Sizzling Spike Sets Seventh Record High in 2014" are actually something we need to take seriously.

Not because "record-high" stock prices are meaningful (at least not the ones we're seeing this year). It's because they're a gross over-simplification of what's really happening in the market, and that breeds confusion -- and bad decisions --for investors.

Yes, it's a fact that many international stock markets have repeatedly hit "record highs" in 2014. But those stock markets BEGAN the year at record highs. So any increase, no matter how small, pushes those markets to "new records."

It also ignores one of the most crucial indicators of the market's health -- stock prices' relative value.

Relative value is huge, whether you're judging stocks or, say, a baseball player's pedigree. Just ask fans of Babe Ruth, who were outraged when Roger Maris broke the Babe's season home-run record with his 61st dinger on Oct. 1, 1961.

Babe fans didn't dispute that Maris "technically" topped Ruth's long-standing record of 60 HRs. They were disputing the relative value of Maris's productivity at the plate, given Maris launched his shots over a 162-game season, while Ruth played in an era of 154-game frames. Ball fans on the Eastern Seaboard still get into fist fights in pubs about whether Maris's record should have been denoted with an asterisk.

(I'm more exercised about the Bonds/McGwire/Sosa steroid era, but that's another blog.)

When stock market fans consider relative value, they should be looking not just at price, but the ratio of that price to the company's underlying earnings. Those ratios -- valuations, in market-speak -- are steady and reasonable, compared to long-term trends.

In fact, valuations today are 45 per cent lower than they were at their pre-tech-bubble peak in 2000. And the earnings today's valuations are based on are 90 per cent higher than they were in 2000.

That tells us -- and our investors -- a few important things.

It tells us stocks appear fairly priced. It tells us that valuations are not, in fact, a giant red flashing light foretelling of an imminent collapse. It tells us stocks still have lower valuations than bonds, which may be a riskier proposition today because of low interest rates.

And it reminds us that you shouldn't make decisions on stocks based solely on price. A $1,000 stock can be cheap, and a nickel stock can be expensive, depending on what those companies are earning.

We know it's easier to bang out a story about "record highs" than explain valuations. What's troubling is that investors see these kinds of headlines and jump to a conclusion that prices are unsustainable and the markets might be on the precipice of the sorts of collapses we endured in 2000 and 2008.

I hate to always be Context Guy, reacting sniffily to the superficial click-bait on the financial media equivalents of BuzzFeed. But Canadian investors are betting their dreams and futures on this kind of information, and they deserve a well-rounded picture.

This more-complex reality would generate some crushingly banal headlines, I recognize. "Earnings and Valuations Suggest Stock Market Is Fairly Priced" will not lure a lot of web-eyeballs or sell many newspaper subs.

So here's a snappier headline to keep in mind, whether you're comparing the greatest ball players of all time, or contemplating your wealth-management adviser's advice on an investment: Context Is King.