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Continued: Is the stock rally almost over or does it have legs? The bull and bear cases

  • Article by: BERNARD CONDON , Associated Press
  • Last update: August 30, 2014 - 7:05 AM

BUYBACK BOOM

One of the biggest forces in the stock rally so far is companies buying back their own shares. Companies in the S&P 500 have spent $1.9 trillion on buybacks since the bull market began in March 2009, according to Howard Silverblatt, a senior index analyst at S&P Dow Jones Indices.

By creating more demand for stocks, buybacks have kept prices rising even as other big investors sell. Mutual funds, investment brokers, foreigners and pension funds have been net sellers of stocks over most of the last five years, according to the Fed.

Companies have pulled back sharply from their near-record buying in the first quarter, but their buybacks are still pushing up prices. And companies in the S&P 500 still have more than $1.1 trillion in cash, according to S&P Dow Jones Indices.

BEAR CASE

STOCKS NOT CHEAP

It's fine to forecast big profit gains well into the future, but what if prices fully reflect expected gains?

That's what many bears think. They cite the price-earnings ratio, or the price of a stock divided by its earnings per share. If a share costs $100 and the company is expected to earn $5 per share in the coming year, the P/E ratio is 20.

The S&P 500 now trades at 15 times what companies are expected to earn over the next 12 months, according to FactSet. That is slightly above the 10-year average of 14.1.

The problem is, P/Es are often not reliable gauges of stock value. They are based on just one year's earnings, which can rise and fall along with the economy.

Many experts believe a better P/E is a "cyclically adjusted" ratio, which averages earnings over 10 years.

It is currently 26. That's far below the peak of 44 it reached in the late 1990s, but it's still very high. Since the end of World War II, the average is 18.3.

THOSE COMING RATE HIKES

The Fed may be able to raise rates slowly without damaging the economy and stock markets. But its record isn't entirely reassuring.

Three of the past five bull markets ended after the Fed increased rates.

If the central bank finds itself scrambling to contain inflation and has to raise rates sharply, stocks could fall 20 percent. Inflation doesn't appear to be a problem right now. But that could change fast if the economy heats up.

STRUGGLING ECONOMIES ABROAD

U.S. companies rely more than ever on foreign economies remaining healthy. Unfortunately, many of those economies are stumbling.

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