After Wall Street's stirring year of record highs, several economists caution that the stock market may have outpaced the nation's economy and be due for a breather.
In the postwar era, the market has usually been overvalued when the total value of stocks exceeded 70% of the nation's economic output, or gross domestic product, according to Wall Street economist David B. Bostian Jr.
Recently, the market's overall valuation has been equal to nearly 90% of GDP, according to Mr. Bostian's own data model. That's the highest market- to-GDP ratio since 1950.
Mr. Bostian, chief economist at Herzo, Heine, Geduld Inc., New York, said he thinks the economy's long-term outlook is bullish but nevertheless feels investors should tread carefully right now.
In particular, he noted, "the massive consumer debt burden that was the imbalance that caused the last recession has returned with a vengeance."
Current stock-price levels also concern Tim Tully of Chicago Capital Inc., who recently warned that the market appears about 10% overvalued. In fact, that has been the case for much of the last six months, he said.
"As a result, January's earnings releases loom ever larger in determining the market's direction over the next couple of months," Mr. Tully said in a recent letter to clients.
Mr. Bostian's specialized market barometer is different from the strategic "market timing" models wielded by Wall Street's technical analysts. And some of those are sending out conflicting signals.
One such timing model, based on moves in the index of Standard & Poor's 500 stocks, flashed both "buy" and "sell" signs almost simultaneously last year, according to James W. Coons, chief economist at Huntington National Bank, Columbus, Ohio.
The economist concludes that vaunted investor Warren E. Buffett has probably been right all along in saying that short-term market forecasts are useless. Actually, Mr. Buffett labeled them "poison."
"No one can know with reliability which way stock prices will head in the near future," Mr. Coons said. "We do know, though, that over long horizons equity values are hurt by high, and especially rising, inflation. And stocks benefit from low, and especially falling, inflation."
Recently, inflation has fallen to the lowest and most stable level in a generation, he noted. Moreover, warning signs of an imminent upturn are absent.
"As a result," said Mr. Coons, "the odds are that long-term stock market performance will fall between the wildly positive returns of the last 14 years (1982-1996) and the disaster of the previous 14-year period (1968- 1982)." Given the outlook for inflation, market performance may be somewhat closer to the more recent period.
"The bull market of the 1980s and 1990s has been fueled by a decrease in inflation from a high level to a moderate level," he said, noting that, even at 3% annually, the U.S. inflation rate is the second-highest among major industrial nations.
"Sustaining today's low inflation rate," said Mr. Coons, "would continue to promote growth in the economy and corporate profits, a moderate level of interest rates, and stock price appreciation.
"Inflation can and should be reduced further, but the largest gains are behind us," he added. That means long-term stock returns from now onward should be lower than the dramatic recent gains.
On the other hand, while inflation has not been banished, a return to the bearish 1968-1982 era seems highly unlikely. In that period, "rising inflation impaired the functioning of the economy and sent interest rates to modern records, devaluing financial assets," he noted.
