NEW YORK (TheStreet) -- Are current stock prices justified?
Given the expectations for economic growth, somewhere in the 2.25% to 2.75% range for the next year or two, is it reasonable to believe in stock prices that are hanging around all-time highs?
Looking at current valuations, price-to-earnings ratios seem to be stretched. Price-to-earnings ratios based on forward earnings seem to be stretched. Bob Shiller's measure, the cyclically adjusted price-to-earnings ratio (CAPE) has reached a level in excess of 27.0, which is substantially above the long-term average, around 15.0 and is getting close to being at its third highest level, exceeded only by the levels reached in 1929 and 2000.
Analysts are trying to determine what might drive further increases in stock prices and the answer keeps coming back to rising earnings. Somehow, some way, earnings are going to have to rise, but with projections for economic growth being so modest, where are those increases going to come from?
Furthermore, the argument is that a large portion of the earnings achieved in the current expansion has been due to cost-cutting and not to revenue growth because of demand factors. On top of this, corporate use of accumulated cash balances to buy back stock and to raise dividends has propelled higher stock prices. These efforts are running out of steam and will not contribute as much to higher stock prices in the future as they have contributed in the past.
This analysis, however, just looks at the aggregate numbers. A lot seems to be going on below the surface and this is important for us to understand. One of the major reasons why this economic recovery has been as modest as it has been is that the United States economy (and the world's) is going through a major transition period. Some industry groups are becoming more prominent, while others are falling behind. One result of this transition is that, on average, the aggregate numbers will turn out to be mediocre by historical standards.