US Stock Markets Are Hitting Record Highs. but Why?

Article excerpt

Stock markets in the United States have been setting records lately, despite economic conditions that hardly seem like a recipe for boom times on Wall Street.

Gasoline has jumped above $3 a gallon in price, yet the Dow Jones Industrial Average recently pushed above 13000 for the first time in its history.

Economic activity in the US is slowing, due in part to a housing- market slump, yet the Standard & Poor's 500 index is flirting with its historic high of 1527.46 set in 2000.

What gives? How far can this stock market go?

One explanation for the bullish performance could be that Wall Street is misreading an economy that faces trouble on several fronts. That would be bad news for future profits.

But other explanations are more prevalent among financial professionals. Two factors in particular stand out: strong conditions beyond US borders and a merger binge that is pushing up share prices of target companies.

"A lot of major companies have done very well with their overseas markets," says Robert Carey, chief investment officer at First Trust Advisors, an investment firm in Lisle, Ill. "The distinction between US companies and foreign companies is getting very hard to draw."

Companies like IBM, Coca-Cola, and Intel - all among the 30 in the Dow Jones Industrial Average - derive well over half their revenue stream from overseas.

In the final quarter of 2006, US-based corporations saw the earnings of their foreign affiliates surge to an annualized level of $272 billion, up 38 percent from the pace in the fourth quarter of 2005. That amounts to about 15 percent of all US corporate profits, as measured by the US Commerce Department.

Emerging markets such as China are a key source of growth for American corporations. But lately, US exports have also been aided by a stronger economy in Europe, where more than half of those foreign-affiliate profits come from.

Record profits, meanwhile, give corporations and investors lots of money to invest. Many companies are buying back some of their own outstanding shares, a tactic for returning profits to shareholders.

Others are using the money as fuel for takeovers.

The merger wave has buoyed share prices in the US and beyond. Media companies such as Dow Jones and Yahoo are among the stocks that have surged early this month on rumors of possible acquisition (by News Corp. and Microsoft, respectively).

Treasury Secretary Henry Paulson, speaking on May 3 to students at the Harvard Business School in Boston, called the past three years "a global economy that's as strong as anything I've seen in my business career."

For now, the good times for American businesses are rolling along, even though forecasters agree that the rate of profit growth is slowing from double-digit rates.

Mr. Carey is in the upbeat camp of investing strategists who think the stock rally has room to run this year - with the Dow reaching 14000 by year-end in a First Trust Advisors forecast.

"The issue is profits," he says. …