Is The Stock Market Too High?

Where are the profits? That is the No. 1 question on Wall Street these days. After three years of stupendous double-digit increases, profit growth has slowed. The worry is that the only thing keeping the market levitating is the Federal Reserve. Doubters fear that all the money the Fed is pouring into the financial system to calm a financial crisis that has now spread to Brazil is pumping up stocks.

But there is another explanation for the market's robust performance. U.S. corporations are getting a bigger share of all the profits made in the industrialized world. Indeed, a massive shift in global profits is under way. The numbers are astounding. In 1992, American companies accounted for nearly 25% of the corporate profits made in the six major global economies, according to J.P. Morgan & Co. By the third quarter of 1998, that share was up to nearly 38%. Look at the trend this way: Seven years ago, the share of corporate profits going to U.S. companies just about equaled the share of the U.S. gross domestic product in the world economy. Today, the U.S. share of corporate profits is nearly twice its share of world GDP. And it's rising as the country enters the 93rd month of the longest peacetime business expansion in modern history.

Conclusion? U.S. corporations are doing better than most of their global rivals, especially the Japanese. In 1992, Japanese companies had a 17.5% share of world profits. By third-quarter 1998, that was down to 7%. There are many reasons for the U.S. improvement, including exceptionally good fiscal and monetary policy, but the most important is the transition to an information economy in the U.S. Information industries generated an amazing 37% of new jobs in 1998. And spending on high tech has boosted productivity. Does this justify each and every wild Internet stock price? Of course not. Does it suggest that the overall market level may not be so crazy? Yes, it does.

The global profit shift is significant. The market's role in the U.S. and world economy has expanded sharply in recent years. Traditionally, the market functioned mostly as a vehicle for raising capital for investment. Today, the U.S. stock market is doing triple duty: It is financing capital investment, domestic consumption, and the trade deficit. Americans increasingly rely on capital gains to maintain their spending. Taxable capital gains totaled $370 billion in 1997 and probably more in 1998, compared with $127 billion in 1992. A rising market is also attracting foreign capital, which is needed to finance America's huge trade deficit. Last year, foreign investors bought a record amount of U.S. equities. And for many with 401(k) plans, the market also is financing retirement. The proposed Social Security reforms could expand that role.

The stock market may be racing ahead of itself, but not by as much as bears fear. The global profit shift makes current lofty stock valuations, high by historic standards, much more reasonable. Millions of individual investors may be more right than the nervous pros.

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