This is the first in an occasional series of stories on the record-breaking expansion of the U.S. economy.
There is little question that the current economic expansion, which will go into the record books as the U.S.' longest at the end of this month, has done wonders for the U.S. equity market.
Since the economy turned higher in March 1991, U.S. corporate profits have surged.
earnings are up more than 265% since then, according to
. And stocks have more than followed suit: The S&P 500 index has added 276% over the past nine years.
There are a number of good reasons why stock prices have outpaced profits in those years. Yields on Treasuries have come down significantly. The makeup of the index, and so the focus of the market, has shifted away from old-economy companies to tech and services -- in 1992, the biggest company in America, with a market capitalization of a little more than $75 billion, was
But apart from that, there's one other major reason why stocks have performed so well: the length of the expansion itself. As we enter a 10th year of growth, it's hard to resist the notion that in some crucial sense things really have changed, that the U.S. economy and markets have somehow matured -- and it may be that the economic cycle is lengthening. If that really has happened, perhaps it makes sense that equities now carry higher prices. With longer expansions, U.S. corporate performance should be less volatile. That would make stocks less risky and support loftier valuations.
chief investment strategist Jeffrey Applegate reckons that's exactly what's happened. He notes that at the beginning of the last century, for every 100 months of expansion, there were 84 months of recession. Over the last three cycles, for every 100 months of expansion, there have been only 14 months of recession. So while stocks might seem pretty rich by historic measures, Applegate thinks they're appropriately priced now.
Caveats, Caveats, We've Got Caveats
There are some assumptions at work here, however, that not everybody agrees with.
For one, though U.S. economic cycles have lengthened considerably since a century ago and over the last 40 years, the process has moderated considerably. "I'm not so sure how relevant the business cycles of a hundred years ago are to today," says Steve Roach, chief economist at
Morgan Stanley Dean Witter
. Most people aren't living on farms these days, for instance.
Moreover, although periods of growth have lengthened, corporate profits do not always follow the same contours as the economy. The U.S. added 4.3% in 1998, for example, but S&P 500 earnings contracted 1%, according to I/B/E/S. "Stocks don't price on economic cycles," says
chief quantitative strategist Rich Bernstein. "They price on profit cycles. And profit cycles appear as volatile as they always have.
does not occur on the income statement."
But perhaps the strongest argument against the idea that economic cycles will be longer from here on out is that past really isn't prologue. There are a number of special circumstances that made the current expansion so long-lasting, points out
economist Phil Suttle. There were high unemployment and spare capacity at the expansion's start, a relatively muted beginning and a profits focus that buoyed capital spending. All of these could be viewed as happy coincidences, which one couldn't reasonably count on occurring again whenever the next expansion comes.
The Fed Factor
Yet there is a final factor that may extend past the current cycle: a
that has been doing its job very well. "Cycles in the past tended to be generated by volatile and inappropriate monetary policy," says Mickey Levy, chief economist at
Banc of America Securities
. "The old rules of thumb still work. It's just that the policymakers are minding their Ps and Qs better."
One hopes -- and there is at least a sense that this hope is well-founded -- that
successors will show the same sense that he has. But then one also recalls the curveballs (the war in the Middle East was one) that have sparked recessions in the past, the way new economic problems have forced policymakers to manage the economy in new ways. And because they were generally slow to learn those new ways, in hindsight they seem foolish. At its present level, the stock market may be discounting a world in which central bankers deftly handle any new problem, making 10-year expansions the norm.
And why not? Good economic policy and a longer economic cycle will both be true until they're not.