Will the 2013 Market Rally End With a Whisper or a Bang?

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Source: http://www.flickr.com/photos/psycho-pics/

Source: http://www.flickr.com/photos/psycho-pics/

The rally in U.S. equities this year to date has been nothing short of amazing. Against a backdrop of dubious economic fundamentals and fueled by highly accommodative monetary policy, the S&P 500 climbed 23.43 percent through Friday, closing that day at a multiyear high of 1,805.09.

The Dow Jones Industrial Average — a slightly more suspect but still relevant metric of overall market performance — closed the same day at 16,035.84, up 19.44 percent YTD and down just slightly from record highs hit at the end of November. Powered by particularly strong years for many of its component companies, the tech-heavy Nasdaq soared 30.53 percent through Friday.

It’s common at this point to expect one of two things to happen: Either the rally will lose steam and equities will stumble through a lackluster 2014, or those who cry “bubble” will be vindicated and there will be a correction.

Fears of the latter abound, and for good reason. The current Shiller price-to-earnings ratio — a PE measure that attempts to smooth out volatility — is elevated and has climbed pretty much nonstop since the beginning of 2013. The current Shiller PE of 25.47 compares against the long-term mean of 16.5 and median of 14.9. The ratio touched a high of about 27.5 in 2007 before equities crashed in the wake of the financial crisis.

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