Stocks may be near record levels but the bull market is not done. Digital technologies permit businesses to use investors’ cash far more efficiently these days, and could easily push up stock prices another 25 percent.
Henry Ford had a great idea—an inexpensive assembly line vehicle—but he needed vast amounts of capital and decades to erect factories, cultivate suppliers, and establish a national dealership network.
In only six years, Google used off the shelf servers and the free internet to convert its novel search engine and an investment of $25 million into a global company worth $23 billion at its initial public offering.
In the digital age, innovators don’t need a lot of money to create a valuable company. Old line industrial firms can use factories and manage supply chains more efficiently. Modern multinationals like GE exploit new products and markets, and generate vast profits, with much less cash than in decades past.
That’s why big U.S. companies are flush with billions in excess profits—they don’t lack for opportunities but need much less cash to exploit those. Along with individual investors, they bid up prices for young companies like Facebook and Twitter, and buy back large blocks of their own stock.
The abundance of financial capital pushes up sustainable stock prices and price-earnings ratios.
The Standard and Poor’s 500 Index, which encompasses about four-fifths of U.S. publicly traded equities, recently closed as high as 1988 with P/E ratio of about 19.60. Over the past 25 years, that ratio has averaged 18.90, and when the index first crossed the 1000 threshold in 1998, the P/E ratio was about 25.Â
Considering how efficiently the digital economy can create wealth from investors’ cash, a P/E ratio as high as 25 and the S&P index trading at 2500 are quite possible
As the Federal Reserve raises short term rates in 2015, medium and long rates will not go up a lot—further supporting stock prices at higher levels.
