Market Correction 2013: With S&P and Dow At All-Time Highs, is it Time to Sell?

Forecasting the stock market is by definition an inexact science. With both the Dow Jones Industrial average and the S&P 500 rising to new highs recently, debate over whether stocks will continue to soar has heated up.

Bullish investors like David Tepper, the billionaire hedge fund manager, insist the stock market will continue rising for the foreseeable future. Other market observers see things differently, arguing the stock market’s rise into uncharted territory makes it primed for a classic market correction. The truth, as it often does, probably lies somewhere in the middle.

The big-picture economic data from the Bureau of Labor Statistics show an economy that is slowly improving, though hardly enough to justify the outsized gains in stock prices since the bull-market began in March of 2009. Unemployment is still three percentage points higher than its pre-recession level in 2007, and that number doesn't account for the many workers who have given up looking for work. A bigger problem for the country's long-term economic outlook is the number of workers who have been out of a job for six months or more: a figure that currently stands at 4.4 million.

Given the less-than-stellar state of the economy as a whole, it seems like now would be a great time to cash out of the stock market and consolidate gains. The problem with taking this view is the stock market isn't simply an indicator of our nation's economic health, it's also a snapshot of investors' confidence in future economic conditions with its own complicated feedbacks.

When stock markets go up, they tend to keep going up as investors see the value of their portfolios rise and so become disinclined to sell. People on the outside try to get in on the good times and so further bid up prices. These factors, along with the fear of leaving the party too early, contribute to soaring stocks even when macroeconomic indicators show a vulnerable economy.

The elephant in the room in all this is the role of the Fed and its use of the unconventional policy tool of quantitative easing to spur economic growth. The Fed has committed to continuing its program of purchasing $85 billion in bonds every month until the unemployment rate falls below 6.5%. This policy has artificially inflated the price of bonds, lowering the interest rate and forcing conservative investors into the stock market in search of higher yields. If and when the Fed ends this policy, as it is hinting of doing sooner rather than later, we're probably going to see a number of investors move their money out of stocks and into bonds, bringing forward the long-anticipated market correction.

As the saying goes, "what goes up must come down," but when it comes to the stock market the million-dollar question is when. With stocks at their highest levels in history, now is probably a bad time to buy, but it may also be a bad time to sell.