A short one today, but an important one. Let's tackle one of Bill's central arguments: Show me the earnings. That is always the big stickler when it comes to this bull market run. As Bill effectively points out, the gain in stock prices overall has outstripped the gains in earnings over the same period.
A couple of points here. First of all, I concur with Abby J. Cohen, the Goldman Sachs strategist, who argues that the relation between earnings and valuations has less to do with the pace of earnings growth than with the duration of that growth. And the longevity of earnings growth continues to surprise investors. Bill argues that growth is anemic--but I argue that growth has continued, especially among the major companies that drive the principal market measures.
This expansion, benefiting from the range of economic and global changes mentioned in an earlier missive, continues to defy conventional wisdom in terms of its durability. And the endurance of the current earnings cycle is a major reason that price-to-earnings valuations have continued to rise. Indeed, it is the consistency and endurance of earnings that has permitted investors to look farther out on the horizon and show a willingness to pay ahead for future earnings. This is one more reason stock prices have outgained the pace of earnings growth.
Even today, deep into this expansion, it is not clear how the earnings well could suddenly go dry. Growth continues apace, even through the teeth of the Asian economic crisis that began back in the summer of 1997. Moreover, low rates of inflation, which we continue to enjoy, amplify price-to-earnings measures, another reason that stock prices have outstripped earnings gains over the past several years.
One can argue that the earnings picture is distorted by creative accounting, and Bill most certainly will make that case. But based on the numbers we have available--both for earnings and inflation--the growth in share prices is not unreasonable. Also, if one argues that earnings numbers and inflation numbers are all hooey, then we really have very little to argue about since all the assumptions required to begin a dialogue will be toast.
Rather than argue in favor of a bubble, I think it is fair to say that valuations are anticipating that the rare confluence of positive events that are supporting stock prices will continue for some time to come. We may see chinks in that thinking from time to time, and that will certainly lead to some problems in the stock market. But that would represent standard market action, not a catastrophic bubble reaction to an unrealistic dream gone terribly bad. The fundamental underpinnings of this market run--solid earnings growth, benign inflation, and continued productivity gains--argue that the stock market has not lost track of its senses. Instead, stock prices reflect aggressive expectations that the good times will continue. If the good times don't, all we'll get is a boring bear market. Not a replay of the disaster that has crushed Japan over the past ten years.