Since 2010, the U.S. stock market has shown incredible resiliency and is nearing new highs, even with all the ongoing concerns about the European fiscal crises, the downgrade of U.S. debt, and the impending U.S. fiscal cliff. Using the stock market as a forward-looking barometer of the economy, the post-recession highs suggest very positive expectations for future business conditions. Some media commentators contend, however, that these new highs indicate a stock market bubble or at least the formation of one. When we examine the facts, what is the market indicating about the economy right now?
This chart plots the S&P 500 (black line) against actual earnings (red line).1 The chart also includes the latest consensus among economists about the earnings forecasts for 2012 and 2013 (two red dots), which are subject to change. Notice how grossly distorted S&P 500 stock prices were during the bubble from 1993 to 2000—the gap between the black line and red line. Those excessive stock valuations contributed to the soft returns of the 2000s as they came back into line with underlying fundamentals. After the financial crisis of 2008, earnings and stock prices began moving together again. Over several recent quarters, earnings actually exceeded stock prices. This data suggests that the U.S. is not experiencing a stock market bubble or heading toward one in the near term.