IS THE MARKET OVERVALUED?
The question, "Is the market overvalued?" is obviously the ultimate question, always, for the market. Markets are either overvalued or undervalued, based on two things; the price of the market, and the earnings supporting those stock prices. When the market is overvalued, it has run ahead of the earnings that support it. When people say the stock market is undervalued, all they mean is, the stock prices probably haven’t fully reflected the earnings of the companies involved.
Therefore, it is from that situation, the relative position of price vs. earnings, that you hear the often talked about, so called "P/E" or, price-earnings ratio. Argument is currently being made that the market is selling at historically high P/E ratios, but I think we have to recognize that history has changed a lot in this decade alone, and that’s what the current strength in the market is reflecting. Those of us who are bullish on the future of this market continue to feel that there is further potential in our "new economy" than other people might suspect.
A little history is order here; if you go back to the end of WW II, we were the only economy around. Much of Western Europe was destroyed by the war, and we, in fact, were sending aid over there in the form of a martial plan. Eastern Europe fell under Communist control, and so wasn’t much of a market either. Over in Asia, Japan was likewise destroyed at the end of the war, and of the two biggest population centers, China was in the process of going Communist, while India was moving to Socialism. The rest of Asia still had a long way to go to even be considered an emerging market.
With that kind of an economic map, American businesses looked at our domestic population of about 200 million people, and decided that production for domestic consumption was the way to go. They turned out to be very right. For several decades American businesses grew and prospered through very little more than domestic production and domestic consumption. It was not until the ‘70s and ‘80s that that began to change.
With that kind of a backdrop investors priced stocks and markets based on American companies having the potential market of some 200 million. Today this has all changed. Enter globalization. In his excellent book "The Lexus and the Olive Tree," which I would highly recommend to any serious reader trying to understand today’s world, Thomas Friedman, the International Financial Bureau Chief for the New York Times, makes the point that when the Berlin Wall fell, it fell on all of us. It changed the world completely and forever. Democratization of information, technology and finance, made all those things available to virtually the entire world without restriction, and made a vast difference in how companies looked at the rest of the world. All of a sudden, American companies didn’t have a slow-growing market of, by then, roughly 240 million. Suddenly, they picked up a potential market of nearly 5 billion, and, dear reader, that 5 BILLION is an enormous number that has absolutely changed the outlook for all companies who want to participate in the new, globalized world.
So, all of a sudden, and especially in this decade, the numbers have changed completely. For example, take the phrase "IntelInside" Most of us are familiar with that phrase, it appears on virtually every computer made today. But what it really means to me is that companies like Intel, and so many more (and, please, this is not a recommendation of Intel in disguise), now pick up a world-wide, or 5 billion customer potential market. And that changes, in my opinion, the way companies should be looked at. Companies that have a bigger and expanded market probably do deserve a higher or expanded price/earnings ratio based on their potential to sell and service future markets. To me, that’s just logical. So, for better or worse, I have no problem with the market at current levels.
Just a word about earnings as well. In the 1970s and 1980s, corporate earnings were exaggerated by inflation. Today, with little or no inflation around, corporate earnings are REAL. Aren’t real earnings more powerful than earnings that are puffed up by inflation? I think so. At the bottom line, it is bigger, better and expanded markets and real earnings that I think are supporting the current market.
(Tom Butenhoff is a First Vice President with J. E. Liss & Company in Milwaukee. The views are his and not necessarily those of Liss Financial Services or the Job Connection/Hiring Network.)