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By Jason Stipp and Christine Benz | 11-25-2013 02:00 PM

Prudent Strategies for a High-Flying Market

Investors queasy over market valuations may consider rebalancing, augmenting their cash stakes, and tilting toward undervalued pockets and proven flexible managers, says Morningstar's Christine Benz.

Jason Stipp: I'm Jason Stipp for Morningstar. The S&P 500 year-to-date is now up almost 30%, following a 16% return in 2012, and now the trailing five-year return annualized is 20%. So, you can't blame some folks for thinking stocks might be peaking. What should you do?

Here to offer some coping strategies for a fully, or maybe overvalued, market is Christine Benz, our director of personal finance.

Thanks for joining me, Christine.

Christine Benz: Jason, great to be here.

Stipp: There is no doubt that we've seen a strong multiyear market record rally at this point, but there is some difference of opinion as to whether stocks are terribly overvalued or just fully valued right now. There is a range of opinions out there.

Benz: There is. Grantham, Mayo, Van Otterloo came out last week with a forecast for domestic equities, forecasting a negative real return for U.S. stocks over the next seven years.

I happened to see Robert Shiller speak at the recent AAII's national conference, and he was forecasting a 2.5% real return for stocks over the next decade. I would say those two would be at the pessimistic end.

Jack Bogle, when I interviewed him back in October, said that he is thinking stocks look slightly overvalued, but he still was forecasting more positive real returns for equities over the next decade. Warren Buffett has also said that stocks are in a zone of reasonableness--I believe that was his wording--right now. So he doesn't think that they're tremendously overvalued, but he doesn't think they're undervalued, either.

I think the really notable absence in all of this, Jason, is that among these respected observers, there really aren't that many bulls. Even though you have the bearish, and people who are somewhat neutral on stock valuations currently, it's hard to find people who are really pounding the table for stocks given the runup that we've seen recently.

Stipp: We can also aggregate our own Morningstar analyst fair value estimates to get a sense of where we think the market is valued right now. What does that data say?

Benz: I look at this all the time on our market fair value graph. 1.04% is the average price-to-fair value for the stocks in our global coverage universe. That's at the high end of where that price-to-fair value has been historically.

Stipp: So we have a range here. Stocks certainly aren't a screaming buy. They look fairly valued to some folks, and they look relatively overvalued to some other folks.

Maybe a good place to start is how to cope with this is what not to do, and certainly avoiding mistakes can be a big part of your success.

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