Are stocks cheap or dear?

In 2008 and 2009, investors experienced gut-wrenching declines and breathtaking surges in stock prices. Stocks are still not back to where they were at the start of 2008, but in the meantime, earnings have declined and dividends have been cut. So where are we now, at the beginning of 2010, with regard to price and value? Is there a compelling argument for the enterprising investor to deviate from a standard, balanced allocation?

First, it's instructive to look at economist Robert Shiller's website, which gives a historical glance at a cyclically adjusted price/earnings, or CAPE, ratio of the S&P 500 Index. (The concept of looking at this metric comes from Graham himself, and Grantham, Mayo, Van Otterloo analyst James Montier calls it the "Graham & Dodd P/E" in his book Value Investing: Tools and Techniques for Intelligent Investment.) Currently, the ratio is at nearly 21 times, which seems somewhat high by historical standards, though perhaps not inordinately so, given very low interest rates. The current multiple isn't nearly as high as the roughly 45 times earnings multiple the market reached in early 2000 or the 35 times earnings multiple it reached in 1929, but it doesn't exactly appear to be a bargain basement multiple either. The average multiple for the index since 1881 is 18 times, according to Montier.

Another possible cause for tempered expectations is Morningstar's own Market Valuation Graph, which shows the market to be 5% overpriced currently. That's not an egregious overpricing and certainly not as high as the all-time high of 14%, but it doesn't appear particularly cheap either. If we dig a little deeper into Morningstar's equity analysis, we see that only 35 stocks currently trade in 5-star territory or far enough below the analysts' fair value estimates to offer the margin of safety warranting a buy recommendation.

After sifting through all of this evidence, it appears that the market isn't cheap. In the last edition of The Intelligent Investor, when CAPE was a bit over 17 times, Graham argued against increasing stock exposure, saying, "It is hard for us to see how such a strong confidence can be justified at the levels existing in early 1972." Clearly, he'd say the same thing today at 21 times. In fact, in his other book Security Analysis, he remarked that buying stocks over 20 times average earnings was speculating more than investing, because that meant you were willing to accept an "earnings yield" of less than 5% on a risky asset.

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Several of the successful market gurus I keep an eye on say the market remains attractively valued -- but not all of them.

Morningstar performance

Morningstar looks at how their stock picks have performed.

5-star wide moat did better than 1-star wide moat.

5-star narrow moat did batter than 1-star narrow moat.

So far, so good.

BUT 5-star no moat did worse than 1-star no moat.

And, in fact, 1-star no moat had the best performance of all.

So the logical conclusion must be, to get the best performance, buy the worst stocks in the Morningstar universe!

[Though it looks like the results were because the worst stocks went completely nuts in 2009 since they were so beaten down. So I'd stick with the 5-star wide moat stocks, which did nearly as well as the 1-star no moat stocks since inception.]

a decade of living dangerously

It was a decade of living dangerously.

With interest rates low and lending standards lower, credit became the currency of the decade.

Exotic mortgage products helped housing prices more than double. Consumer spending shot up more than 48 percent - even while wages stagnated - as shoppers snapped up big-screen TVs, gadgets like iPhones and fashion labels like Gucci and Jimmy Choo.

The amount of debt consumers carried shot up 67 percent, peaking in June 2008 at $2.57 trillion. Likewise, businesses large and small borrowed money to finance a wave of mergers and expansion.

Then, the crash.

At the end of 2006, homeowners began defaulting on their mortgages at an alarming rate. The foreclosure rate broke record after record. Lenders failed by the dozen. In late 2009, more than 14 percent of homeowners with a mortgage were either behind on their payments or facing foreclosure.

For Bear Stearns and Lehman Brothers, which bet too heavily on securities backed by risky mortgages, the losses were fatal. The ripple effects across banking and other industries, sparked a recession that led to massive job losses and drastic cutbacks in consumer spending.

There are some signs of a recovery, but not of a quick rebound.

Stocks have recovered a portion of their losses, but it will appear on most investor's balance sheet as a lost decade - the first 10-year period investors saw a negative total return.

Nearly 27 million people are unemployed or underemployed. Consumers have cut back on spending and started saving, but it will take years to dig out of the debt hole. Home prices have receded to 2003 levels, and further in Arizona, California, Florida and Nevada.

The decade that began with the view that the sky was the limit is ending with both investors and consumers feeling grounded.

Here's a look at some of the key moments in personal finance in the 2000s.

fund managers of the decade

Morningstar's picks for the fund managers of the decade: Bill Gross, Bruce Berkowitz, David Herro.