Is irrational exuberance back? The Dow Jones industrial average has risen 50 percent in the past three years and is now about 500 points, or less than 5 percent, below its all-time bubble-inflated high of 11,723. The Standard & Poor's 500 is up more than 60 percent and is also trading at a five-year-high range. It's now only about 200 points below its March 2000 peak of 1,527.
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Nervousness about last week's rallies prompted some selling early this week. But economists say this time around the exuberance is more rational. While stock prices have been rebounding steadily, corporate profits have been skyrocketing to new records and are 35 percent higher today than they were at the last economic peak in 2000.
While profits probably can't continue rising at that torrid pace, they are at least providing a firm foundation for today's stock values. The last time the S&P was trading above 1,300, the price-to-earnings ratio was in the high 20s, says S&P senior index analyst Howard Silverblatt. But this time, the S&P is trading at 17 times reported earnings. Over the long scope of history, the S&P has traded at an average of just 15.7. And if you consider the past 18 years or so of low interest rates, the average big stock has traded at 23 times earnings.
Since the textbooks tell us that stocks represent a share of a company's ownership and profits, this rally might actually be based on reasonable fundamentals. That's one reason for S&P's prediction that its index could gain another 4 or 5 percent before the end of the year.
