THE BLOG
06/18/2013 04:17 pm ET | Updated Aug 18, 2013

Last Tango on the Titanic?

I don't think so. In recent weeks stock markets in many parts of the world have declined, sometimes quite sharply, as in Japan where the previous gains had been strongest. This has led a number of people to fear that the next big move of stock prices will be down. Among the reasons they give for this fear are the following:

• Stocks have risen very fast in recent months and even more substantially in the past four years, often reaching new highs, so they are likely overpriced.
• The Federal Reserve has been reducing the time until it expects to start cutting its bond purchases.
• Central banks in Europe have not taken any new initiatives to stimulate their economies or support financial markets.
• The Japanese central bank seems already to have done just about everything it could think of to win Japan's long battle with deflation.

For these reasons, stock market skeptics continue, interest rates on long-term bonds and mortgages have been moving up by noticeable amounts and will probably continue doing so. This, in turn, will impede the growth of economies and businesses and put downward pressure on stock prices. Finally, many would add that the world faces a sea of troubles, including global warming, political gridlock and the proliferation of extremist politics and violence.

Are Stocks Expensive?

Although stocks have risen very rapidly in the recent past, it is worth remembering how far they fell before they rose. In most of the world, particularly Europe and North America, markets are at approximately the same levels they were at their peaks in 2007 and 2000. But in the meantime dividends and profits have been increasing at a steady pace despite the painfully slow growth in economic output and employment. A buyer of U.S. stocks today pays a similar price to what she would have paid in 2007 or 2000; but acquires a stream of profits that is nearly 40 percent above the 2007 level and almost 85 percent above the 2000 level. Today's valuations of earnings and dividends are not extreme compared to their past ranges. However, the proper value of stocks does not depend on what they earned and paid last year or even today, but rather on what they will provide in the future.

A Penny for your Thoughts; a Treasure for your Stocks

What are the prospects for continued growth of common stock earnings and dividends? Corporate profit margins are now at record high levels. Despite 13 years of slow growth, two recessions, the bursting of the dot-com bubble and the financial crisis, earnings on U.S. stocks have increased by 85 percent since 2000. Although, as socially conscious citizens we might strongly prefer that profit margins go down so that wages can go up, the political reality of our representative plutocracy is that the votes do not exist in Congress to bring this about, nor will mythical "market forces." Slow growth itself contributes to faster profit growth for stock investors. First, it leads to more unemployment and depressed wages. Second, it reduces the need for businesses to invest for future growth, freeing cash to be used for buying back their own stock and paying out more in dividends. This is exactly what has happened since 2000. And it is likely to happen in the future as long as we are living in the slow-growth aftermath of the financial crisis, which is likely to be the case for about another five years if we continue to follow the usual pattern after previous crises.

Rising Interest Rates

Many investors and commentators believe that rising interest rates on long-term bonds and the always nearer day when the Federal Reserve will decide to increase its near zero target for the Federal Funds rate are a pair of dangerous icebergs which threaten to sink economies and stock markets. But these prospects -- the one perhaps just starting over the past few weeks and the other still somewhere between one and three years in the future -- should more properly be seen as heralds of renewal rather than instruments of destruction. Interest rates are rising in the United States because prospects are improving for continued or strengthened economic growth. And bond interest rates have increased in Japan precisely because investors believe that the government's new programs to stimulate positive inflation and real economic growth will succeed. The history of financial markets is full of examples that high interest rates and high inflation are bad, very, very bad, for stock markets.

But rising interest rates and inflation are not the same as high interest rates or inflation. In the past, when long periods of very low interest rates have come to an end, there has usually been some short-term turbulence in financial markets such as we have seen recently. But, in each case the event marked the beginning or continuation of a very substantial and prolonged increase in stock market levels.

A Sea of Troubles

But this time isn't the world in freefall toward total destruction? Polar ice caps and glaciers are melting with increasing speed while humans are adding more CO2 and other pollutants to the atmosphere and destroying other species at an accelerating rate. Coupled with the continuing proliferation of nuclear weapons, political gridlock, the increasing violence and intransigence in domestic and international politics, there seems to be a growing chance that the human species itself will disappear far sooner than the average ten million year life span of species, as the geologist Charles Langmuir has observed.

All of this is enough to make us freak out, weep, rage and perhaps wish we were not invested in the stock market at all. But, it is not enough to move the stock market, which is notoriously more concerned with whether the earnings of, say Apple, will be a few cents higher or lower than expectations this quarter than when or whether human life will end. Nor is the stock market unique. Most of us go on about our daily lives even as ice caps melt, New York subways flood with seawater, bombs explode in Fallujah and Timbuktu, and innocent prisoners, held in Guantanamo for more than a decade, continue a hunger strike. We went on during the Cuban missile crisis. We all go on, even though we know that we ourselves will die, often living our usual lives up to the very last moment. So, not to carry on forever about this -- the simple truth is that the most important things in the world are generally not important to financial markets.