Already this year, the S&P 500 index of U.S. stocks has gained 11.8%, not counting dividends. With just one more push like that it will hit an all-time high.
That has investors wondering if prices have once again gotten frothy. By one measure, they haven’t. The 500 index trades at 13.3 times Wall Street’s prediction for 2012 company earnings–on par with its historic average.
Another measure bodes worse, however. That’s a comparison of the total value of U.S. shares with the yearly output of the U.S. economy (see chart). The stock market is once again the larger of the two. When that happened during a dotcom stock bubble in 2000 and during the U.S. housing bubble in 2006, the result was a stock plunge in subsequent years.
Will the same thing happen this time? That may depend on what happens overseas.
The purpose of comparing stocks with the economy is to remove volatile earnings from the math. Company earnings tend to swell during periods of growth, when share prices are likely to rise, and shrink during downturns, when shares often tumble. As a result, it can be difficult to spot a bubble using price-to-earnings ratios, because earnings are likely to be unusually high during market tops.
At the moment, U.S. earnings are near a record high as a share of the economy. Over the past 80 or so years that has tended to mean that earnings are about to shrink.
Thus, the chart. If share prices are constrained by earnings, and if earnings are constrained by the size of the economy, investors might as well compare share prices with the economy directly.
But what if earnings are no longer constrained by the U.S. economy? A recent book titled “This Time Is Different” documents the long history of market watchers claiming, unwisely, that valuation rules have changed. But this time things might really be a little different.
Fast economic growth in markets like China, India and Brazil has caused U.S. companies to grow their overseas revenues faster than domestic ones. The average S&P 500 company now collects an estimated one-third of revenues overseas. For tech companies, the figure is over half. And tech has become the largest sector in the S&P 500 (and the one with the fastest earnings growth).
If that’s a permanent condition, the chart is nothing to worry about and earnings for U.S. companies have shifted higher for good.
It might not be a permanent condition, of course. Over the long term, as emerging markets become developed markets, they may produce companies that compete more effectively with the likes of Apple (AAPL), ExxonMobil (XOM) and Wal-Mart (WMT) for high-value goods and services, even on U.S. shores.
That’s about as far-fetched as a Korean luxury car. Only sixteen years ago, the International Monetary Fund reclassified Korea from an emerging market (like China) to an advanced one (like Japan). Today, Samsung is dueling with the iPhone for smartphone dominance, and Hyundai is seeing double-digit sales growth for its $40,000 Genesis and $65,000 Equus.
For now, however, better to cheer those emerging markets on. U.S. share prices may depend on them.
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For most of the time represented on that chart, stock prices are above the GDP line. This sounds a lot like what you hear from sportscasters from time to time “Team X loses 98% of the time that they score less points than their opponent” Hmm, really? I agree with Sullij6, looks more like a nice base being built. That being said, I’d also need to see a longer chart of this relationship to really draw any conclusions.
I suppose you want the economy to regress to the speculations of real estate and derivatives under the previous administration so that you can cash in some more…..
ON NOVEMBER 7TH THE WORLD ECONOMY WILL BEGIN A HORRIFIC CRASH
Oil prices will be part of the crash.
But, it’s the U.S. Treasury Issues, junk by any standards.
Interest rates are held down by FED Bernanke.
Everything wants to sink but can’t!
Everyone is holding on for the Presidential elections.
If President Obama wins, then more unsustainable deficits, more FED Bernanke money printing, more inflation, no jobs.
If Candidate Romney wins, he will not be able to fix the damages fast enough of the two former presidents, Bush and Obama.
President Bush corrupted the system and destroyed the Housing Market and Middle Class. President Obama engineered with FED Bernanke and Secretary Geithner a false economy build on sand e.g. stimulus, monetary policy, money printing, and socialistic leanings.
On November 7th, 2012, or shortly thereafter, expect a 30% drop in the Stock Market while oil prices rocket.
The World economy – in deep trouble.
Warmest,
Richard Michael Abraham Founder The REDI Foundation http://www.redii.org
At the end of April, the DJ Total Market stood at 14,638 and the GDP at 15,462. Wonder how the chart data arrives at a value for the market of stocks?
Your chart looks like there is a consolidation happening with rising bottoms up against a resistance level, that could very well mean that the GDP is ready to “break out” above historical levels, but your chart only goes back to 1987, it would be helpful to see more cycles in the historical data or at least a better discussion about how the two are correlated historically.
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