In this month’s column, I would like to turn your attention back to the stock market - that wonderful world of investments we can either love or hate, depending on the season, or the moment. In this day of 24-hour news and instant access to market updates, we can both love and hate the market in the same day.

Lost in all of this moment-to-moment drama is the understanding that the markets are an investment world measured in years and often decades. Each time the markets race upwards, we can be caught up in the euphoria of “It’s going to be different this time,” and each time the markets fall we hear “Who could have predicted it?”

The Ups And The Downs

The underlying fact of the stock market is there can be significant risk. This is both good and bad for you as an investor. It is good because without this risk, the stock market would provide low returns. It is bad for all the obvious reasons, beginning with the fact that one can lose 50 percent of his investment in a single year.

When it comes to the market, we often fail in fully appreciating this risk we are taking when the market is soaring, and by overstating the risk when the markets are way down. The $64,000 question is always: “What is the market going to do next?” and the bottom line answer is: no one knows.

Anyone who tells you they can predict the short-term fluctuations of the stock market is either fooling you or fooling themselves. That said, it doesn’t mean we can’t identify times of greater risk; it just means, according to John Maynard Keynes: “The markets can remain irrational longer than you can remain solvent.”

How To Read The Signs

Since we can’t know with certainty where the markets are headed, we at least need to know how to assess the level of risk. Let’s quickly review a couple key indicators and what they are telling us right now.

One of the most well-known is the price to earnings (P/E) ratio. Historically the P/E ratio averages 15, but today it stands at 22. That number, while high, doesn’t mean the markets will fall, because the markets exceeded that number for two and a half years in the late '90s. It should, however, be viewed as a warning flag, and it means you should be cautious.

A lesser-known, but possibly more-important, ratio is the price to dividend (P/D) ratio. While many factors can affect earnings, dividends are usually a very accurate forecaster of a company’s health. The current ratio is right around 55, while a historical average for the last 50 years is around 37. Once again, that is a warning flag.

Take these valuations and throw in the uncertainty surrounding our economy, real estate and national debt and you have a precarious stock market. As of the middle of last month, we have seen a small pullback in the market of six to seven percent, which could be the beginning of a downturn – or, just as likely, a brief dip followed by increases.

The point is, at this time you should invest in the stock market with great care. Summer is a great time to review your holdings, consider the amount of risk you are taking and think about reallocating your portfolio after the massive gains in the last two years.

Am I saying the market is heading down? No one can predict the next few months. What I can say is the signs are there to indicate we aren’t out of the woods yet and the stock market will continue to carry above-average risk, thus potentially below-average returns, for the foreseeable future.

Take Action

More than anything else, you should review your holdings and make sure your current investments match the amount of risk you are willing to take. It’s always after the fact that we realize we should have been paying closer attention.

William Jordan is a nationally recognized financial advisor and well-known speaker on a variety of financial and investment topics. To attend his free Maximum Income Workshop, contact his office at (949) 380-8600 or click on www.WilliamJordanAssociates.com.