Getting an 11 percent jump in stock prices in a mere two weeks ought to make us stand up and cheer. But investors can be forgiven for not shouting too loudly, given that even the two-week surge beginning Sept. 21 still leaves them so far below the peaks of early last year.
Yet despite that gloomy backdrop, the case for optimism may be getting stronger.
For one thing, the recent stock market bounce shows there are plenty of investors who think prices are heading upward, else they would not be bidding prices higher. Perhaps they'll keep at it.
The occasional shock, such as disappointing corporate earnings, has not ignited panic.
Investors seem to believe the country's military response to the terrorist attacks will be careful, well-coordinated with allies and supported by the key Muslim countries. A Vietnam-type quagmire seems less and less likely.
The Federal Reserve's interest rate cuts and President Bush's $75 billion economic stimulus proposal has generally been well received by many analysts, who suggest the economy could turn around in the first half of 2002.
Historically, stocks have begun to recover about six months before the economy has, meaning stocks could start a rebound right now.
Check the numbers
Consider also the improving picture for key indicators, such as the ratio between stock prices and corporate earnings. Wall Street analysts estimate a P/E ratio of 20 for the Standard & Poor's 500 for the 2001 fiscal year. For 2002, they project a P/E in the 17 to 18 range. Compare that to the backward-looking P/E current share prices divided by the past 12 months' earnings. It is nearly 35.
The higher the P/E, the riskier the market; the lower the P/E, the safer it is and the more likely that prices will rise. Essentially, analysts are predicting an earnings rebound that makes today's stock prices look fairly reasonable.
Many investors know that the S&P 500's P/E has averaged about 15 over the long term, making projected levels of 17 to 20 still seem rather high. But the long-term average includes some very different periods.
In the '50s, for instance, investors settled for lower stock-price gains than they did in the '90s, keeping P/E ratios in the low teens. But modest gains in stock prices were supplemented back then by dividend payments that, for the S&P 500 stocks, were generous by today's standards. For much of that decade, the index's dividend yield dividend payments divided by stock prices exceeded 5 percent. Today, it's less than 1.5 percent.
Today, many investors are taxed more heavily on dividends than on profits from stock price gains. So rather than raise dividends, many companies reinvest profits in ways they hope will boost share prices.
Without getting into a lot of math, greater emphasis on share prices over dividends pushes the "normal" P/E ratio higher than the oft-cited long-term average of 15, making a projected level of 20 seem reasonable.
In addition, P/E ratios tend to be higher when interest rates are low, as they are now.
To understand that, flip the P/E ratio over to produce a figure for earnings yield earnings divided by price. Thus, when price is 20 times earnings (a P/E of 20), the earnings yield is 5 percent. A dollar invested brings 5 cents in earnings like earning 5 percent in a savings account.
If savings accounts were paying 7 percent, that wouldn't be very good. But since savings accounts are paying only 2 percent or 3 percent, a 5 percent earnings yield on stocks (or a P/E of 20) looks pretty generous. Indeed, you can imagine the earnings yield going lower (the P/E going higher). We'd get a lower yield if stock prices rose.
Stocks also benefit when competing investments, such as bonds, seem a poor alternative. These days, to get more than 4.5 percent on a safe Treasury bond you have to tie your money up for at least 10 years.
All in all, stocks look pretty good. Assuming, of course, that no new catastrophe comes along to ruin things.