People pay up for something that they know is expensive for a few reasons: Either money is no object, the item is of top quality or the buyer thinks it will be worth more as circumstances change over time.
American stocks are definitely pricey, with the median stock carrying a higher valuation than 98% of the time in the last 40 years, says Goldman Sachs. While low interest rates and inflation help explain this, they don’t make equities a bargain for anyone looking for future returns.
One reason that folks are paying up for richly priced stocks is that money – for many – is not much of an object right now. U.S. companies have issued some $700 billion in new debt so far this year. That’s ahead of the all-time record pace set last year – and is enough to pay off the total national debt of Greece two times over.
Companies, through their own profits and all that debt raised, are acting as if no price is too high to buy their own stock. Share repurchases are on track to exceed $600 billion this year.
This recycling of cash from customers and bond investors to shareholders has been and remains a key source of support for stocks.
Investors in turn are using higher stock values as collateral for a record level of margin borrowing. While this is more a reflection of high stock prices than a cause for outright concern, it fits with a picture of an abundance of money driving investors to be less price sensitive in bidding for shares than they’d otherwise be.
As for the “top quality” issue, it’s easy to find commentators to point out the virtues of the U.S. as an attractive place to invest: High profit margins at many of the world’s best companies, sturdier economic fundamentals than most developed-country peers and a stronger currency that suggests it’s a capital magnet.
This, of course, has been true for some time, and this year the U.S. market is flattish while European and Asian equities gallop higher – which suggests that America’s virtues were largely priced in.
Which brings us to the third reason people buy expensive things, the idea that they’ll be worth more to someone else over time. As relates to stocks, the two clear ways they can grow to be worth more to another buyer is for the business environment to improve a lot, or for other bidders with their own ready cash to pay a higher price. This week we’ll have a test for both these factors.
It’s a very busy week for economic data, from personal income and spending to manufacturing indexes to the May employment report. While it’s never clear exactly what the market wishes for in the numbers, it’s likely that investors would prefer some evidence that growth is picking up in the second quarter after yet another no-growth start to the year. With the Federal Reserve believed to be leaning toward lifting rates, investors want to have the growth picture improve to make such a move more understandable and palatable.
More immediate, though, is the M&A story - the way companies are now eagerly paying up for competitors in order to build scale and acquire growth by financial maneuvering. May 2015 was the busiest year for announced M&A deals ever – topping two other tallies not far from market tops in 2007 and 2000. Time Warner Cable Inc. (TWC) and Broadcom Corp. (BRCM) were dispatched last week, and today Intel Corp. (INTC) is buying Altera Corp. (ALTR), as rumored, and we have reports that health insurer Humana (HUM) is entertaining bids.
While the world economy and total stock market values are both a good deal higher now than in 2007 or 2000 – and this cycle is unfolding over a longer stretch of time -there’s no mistaking the fact that corporate coupling is starting to become quite popular. And as that happens, prices elevate until the next potential buyer balks.
This doesn’t seem imminent. But, with regard to this bull market, it also doesn’t feel at all early.
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