Pricing power fueling hot stock market

Monopoly pricing power may be keeping U.S. corporate earnings margins high and may justify even higher equity prices, but the economy is increasingly less competitive and vibrant as a result.

The markups that firms charge customers above their marginal costs have gone up and up in recent years, from 18 percent in 1980 to 67 percent by 2014, according to a study by economists Jan De Loecker and Jan Eeckhout.

That jump has created the conditions to support today's high stock market valuations. Not only are companies rolling in cash thanks to high markups, but their need to share the benefits with lower-skilled workers has diminished.

All this is slowing economic growth, lowering labor force participation, and lowering both skilled wages and the demand for capital. These factors have been in part behind the Federal Reserve's decision to provide cheap money that has helped to drive up asset price valuations.

This has not gone unnoticed by equity investors. While the S&P 500 stock index in 1980 traded on a multiple of only about nine times the earnings of the previous 10 years, today it trades at a multiple of almost 30.

That's a richer market than at any time in history save just before the 1929 crash and the dot-com debacle at the turn of the millennium.

To be sure, equity prices reflect a complex, often muddled blend of factors, not just the ability of firms to extract profits from sales but also interest rates and the prospects for future growth, both in firms' market share and in the economy as a whole.

For margins to fall and stock prices to go with them, several things would need to happen, none of which seem imminent or terribly likely.

First, government could, as it has in other eras, take a more activist approach to antitrust policy and law, working out and eradicating bars to competition. That would be good for just about everyone but share owners and executives at high-margin earning firms, but given the current run of events, it is understandable that investors don't expect it.

The Fed could also decide that the costs of supporting employment, output and inflation resulting from the monopoly power is not worth the risk, and then hike interest rates.

Unless government policy, in the form of antitrust law, fills that void, don't expect the Fed to stand back and watch.

But high margins and high stock prices, then, may be with us for a good long while.