There has been an awful lot of discussion lately on the topic of stock market valuations. Yale's Robert Shiller, who won the Nobel Prize in Economics in 2013, has been quite vocal with his view that stocks are extremely overvalued at this time and that investors should be worried.

In addition, billionaire investors like George Soros, Carl Icahn, and last week, Sam Zell have also publicly stated their concerns about the current levels in the stock market. All three are calling for a BIG correction at a minimum and have been preparing their portfolios accordingly.

However, as we have detailed previously, our view is that valuation metrics have to be adjusted for the current environment (i.e. the last 20 years) and that taken within this context, stocks are currently no worse than fairly valued at this stage of the game.

However, it is also important to recognize that after a stellar 5-year bull run, stocks are NOT cheap. A fact that causes some folks to fret and value oriented investors to struggle.

Finally, it is vital to recognize that valuation indicators are utterly useless when it comes to the timing of when bull markets end. Remember, bull markets don't just end because stocks aren't bargains anymore. No, historically bull markets end when the economy falters, the Fed gets aggressive, or an external shock occurs.

The key is to understand that any discussion of value - relating to ANY asset class - is a big-picture issue and best used by those with time-frames of 5-10 years. Remember, as John Maynard Keynes effectively said, markets can appear to stay irrational (something that is always in the eyes of the beholder) longer than someone playing the opposite side of the trade can stay solvent.

So, with the appropriate caveats out of the way, let's see if we can't find some value out there.

So, What's "Cheap" These Days?

On the topic of finding value, every now and again, it is an interesting exercise to look around at the various asset classes in search for areas that might indeed be undervalued or "cheap." To be sure, this is a VERY long-term game and isn't something we practice with client assets. However, understanding what is "cheap" can help one to understand what is happening in the markets from a big-picture standpoint.

We've established that while stocks are not overvalued, they are also not cheap. The chart below is Exhibit A in our argument on the subject.

So, stocks aren't cheap. What about bonds? Well, with interest rates remaining near historical lows it is easy to recognize that bonds are actually very overvalued and likely to enter a secular bear at some point in the future. (However, the timing of this widely anticipated move has been challenging to say the least.)

A review of global stock markets produces a similar valuation perspective to that of stocks in the U.S. - not cheap, but not overvalued either. A weekly chart of the iShares Emerging Markets ETF (NYSE: EEM) over the last 10-11 years makes this point fairly clear.

Next up, let's look at commodities. In this space, one can argue that the commodity index as shown by the PowerShares DB Commodity Index ETF (NYSE: DBC) is certainly at the low end of the range seen over the last few years.

However, from a longer-term perspective, it is impossible to argue that commodities such as gold (NYSE: GLD) or silver (NYSE: SLV) are cheap after a secular bull run lasting more than a decade.

Although the gold-bugs will likely disagree (because the answer to any investment question for this crowd is to "buy more gold"), it appears that the secular bull run in Gold may have ended. But, to be fair, Gold has corrected enough to perhaps warrant a solid trade to the upside. But then again, a break below 115 on a weekly basis would be a problem.

Let's now look at real estate. After the out-and-out crash seen in this market during the credit crisis, it might be easy to fall into the trap of thinking that real estate might be cheap and a good place to invest these days. However, the chart below paints a different picture.

In fact, the IYR - the iShares U.S. Real Estate ETF (NYSE: IYR) shows that prices of REITS are back to levels seen in 2006. Therefore, one could actually argue that real estate is overvalued at current levels. But in any event, it is quite clear that real estate is definitely not cheap here.

So to review, stocks aren't cheap, bonds are overvalued, emerging markets look to be fairly valued, the commodity index and gold/silver could be ripe for an intermediate-term rally, but are NOT cheap from a long-term perspective, and real estate is no longer at bargain-basement levels after a 5-year rally.

But We DID Find Some Value In...

However, in our search for value, we did find one asset class that is TRULY cheap by historical standards. And while some may not agree that volatility is even an investable asset, let alone an asset class, "Vol" does appear to be poised for a big move.

Tomorrow, we will dig into this situation and try to determine if there is an opportunity here.

Turning To This Morning

Geopolitics are back in focus this morning as the ceasefire in Ukraine appears to be in a fragile state, President Obama is planning new military efforts to combat ISIS, and the EU is talking about more sanctions against Russia. In addition, the Eurozone September Sentix Economic Index was disappointing. As such, European markets are lower and it looks like stocks will come off of the new highs set on Friday's close when the opening bell rings on Wall Street. There are no major economic reports scheduled for release here in the U.S.

Pre-Game Indicators

Here are the Pre-Market indicators we review each morning before the opening bell...

Major Foreign Markets:
    - Japan: +0.23%
    - Hong Kong: -0.20%
    - Shanghai: closed
    - London: -1.02%
    - Germany: -0.17%
    - France: -0.35%
    - Italy: -0.41%
    - Spain: -0.64%

Crude Oil Futures: -$0.68 to $92.61

Gold: -$0.70 at $1266.70

Dollar: lower against the yen, higher vs. euro and pound.

10-Year Bond Yield: Currently trading at 2.437%

Stock Indices in U.S. (relative to fair value):
- S&P 500: -3.56
- Dow Jones Industrial Average: -39
- NASDAQ Composite: -6.27

Thought For The Day:

Treasure the love you receive above all. It will survive long after your gold and good health have vanished. - Og Mandino

Important Reminder: In order to keep pace with our growth, better serve our advisors and clients, and to provide scale for future growth, Heritage is teaming up with CONCERT Global - an SEC Registered Investment Advisor with more than $2 Billion in assets under management. CONCERT will provide more robust back-office, compliance, technology, and trading infrastructure. Client packets to make the transition will be arriving in the coming weeks.

Positions in securities mentioned: None

Wishing you green screens and all the best for a great day,

David D. Moenning
President, Chief Investment Officer
Heritage Capital Research
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