New Stock Market Highs…Are They Justified?

Well, the United States stock markets hit new highs at the close of the week. This has been about the fourth week in a row that the stock markets turned in such record-setting performances.

What are investors seeing? What future numbers are they building into their forecasts?

What are the papers saying? The New York Times has the headline “Shares Extend Gains on Overseas Economic News.” The Financial Times asserts “Central Banks Ease Investor Fears After Unsettling Signals on Growth.” And, the Wall Street Journal adds on “US Stocks Close at New Records,” although the paper edition has the headline, “U. S. Shares Can’t Match Global Peers.”

Bottom line seems to be the efforts of (OTCQB:SOME) central banks in the world to “Do what we must” to stock inflation, as stated by Mario Draghi, the president of the European Central Bank.

This implies that the investors of the world are basing their stock buying on the “promise” that the central banks of the world will not let the stock market crash. The reports do not indicate that the attention is on unemployment or economic growth…but on “stoking inflation” and not letting stock market prices fall.

It is common knowledge that the Federal Reserve has purposefully sought to encourage the rise in stock prices. We know that the Fed’s econometric models contain equations that show consumption expenditures are determined by wealth holdings, and that a major component of wealth holdings is the value of stocks…so, if stock prices rise, consumer wealth increases and consumption expenditures will rise, hopefully spurring on the economy to greater rates of growth.

This was “gospel” to former Fed Chair Ben Bernanke and the current chair, Janet Yellen, has also been observed as a believer.

A minor problem here is the fact that stocks are not held by a major part of the people in the United States and when other assets are not appreciating in value the way that stock prices are for the wealthier, then maybe consumption doesn’t really respond across the board.

Still, the Federal Reserve seems to be committed to seeing stock prices remain at high levels…this seems to be almost a mantra. And, we know, investors should not fight the Fed.

As far as the economic growth is concerned, we know that the United States has not performed in an outstanding manner since the current recovery began. The US is performing a lot better than many other countries, but, in terms of the historical record over the past sixty years, it is not doing that well.

In the five years beginning with July 2009, the compound rate of growth of the United States has been a compound annual rate of 2.2 percent. That is through the second quarter of 2014. The third quarter growth rate, year-over-year, is just 2.3 percent.

After the last meeting of the Federal Reserve’s open market committee meeting, projections of future economic growth as seen by the officials of the Fed indicated that these leaders of the Fed did not expect the annual growth rate to go above 2.5 percent over the next few years.

This is a little lower than we, in the United States have come to expect. The compound rates of growth for the United States, per decade, over the three decades ending in 2000 were 3.2 percent, 3.3 percent, and 3.4 percent. Note the “catch-up” in the years after World War II, when the compound rate of growth for the 1950s was 3.6 percent and was 4.3 percent for the 1960s.

The current rate of economic growth is interesting because of work done by Lant Pritchett and Larry Summers, former Secretary of the Treasury, amongst other things. They have recently published research that indicates that economic growth in countries around the world have the tendency to “regress to the mean” over time. That is, in their research, the economic growth tends to regress back to around a 2.0 percent annual rate of expansion over time.

This paper specifically was applied to the major countries in Asia, some of which have been experiencing growth rates in excess of 6.0 percent. But, they cite other research that indicates that this hypothesis applies to other areas of the world as well.

If the Pritchett/Summers work holds up, then it might just be the case that economic growth in the United States might not rise above 2.5 percent any time soon.

Another argument for slower economic growth is the one I have presented from time-to-time. That is the idea that the current period of very slow growth might be associated with the transition of the economy from an industrial base to one founded on information technology. This would be something like the trans formation that took place in the early 20th century that culminated in the 1930s as the economy moved from an agricultural base to an industrial base.

If one accepts either of these ideas, then one must conclude that the US economy cannot growth much more rapidly than it has over the past five years. And, since we are now in the sixth year of the economic expansion, we are also in the fourth longest economic expansion since the end of World War II.

One of the things that seems to characterize this expansion over others is the relative steadiness of the recovery. We have not had the wide upswing in the early years and we have not seen a major slowing in the later years. Corporations have not gone overboard on engaging in mergers or acquisitions, even though many of us believed that they were gearing up to do so by building up their cash reserves at the beginning of the recovery. These businesses have not overdone in investing in plant and equipment…or, in inventories. They have not loaded up on the hiring of labor. Furthermore, housing has not entered into a boom period as has happened in most economic recoveries. So things have been very calm…and prognosticators have spent a lot of their time looking for “green shoots”…although this time around the “green shoots” observed have not led anywhere.

So the Federal Reserve has gone along, pumping money into the economy, not wanting to err on the downside, as they were criticized for doing during the Great Depression, and not wanting to make a mistake as it did in the 1937-38 period when they unfortunately tightened up and created another depression. The effort has been to err on the side of monetary ease.

And, the Fed has wanted to see the stock market rise so as to boost up the wealth of the American public.

The picture I am drawing should be pretty obvious by now. It appears as if there are some good reasons why the United States economy is not going to “take off” when it comes to high rates of growth in this recovery. Second, the economic recovery seems to be taking place without much over-spending or over-reaching in terms of corporate behavior. Third, a transition could be taking place where the economy is progressing toward a structure based primarily on information technology and this transformation will just have to work itself out.

Within such an environment, the Federal Reserve does not want to see stock prices go down…even if it cannot spur on much more economic growth. If investors do not think it beneficial to fight the Fed, then stock market prices can continue to stay at current levels…or above. It seems as this is what we are observing…in the United States…and in other parts of the world.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article. (More…)

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