“With the economy in recession, the rate on three- month Treasuries is below 2.25 percent. The last recession with rates that low ended in 1958,” write Floyd Norris in today’s New York Times.

“So it seemed reasonable to look at what happened then. The good news is that it was a typical recession for the stock market, which reached its low in October 1957, six months before the recession ended.”

“Such lead times are typical. If, as many expect, this recession will end in the first half of next year, then it is reasonable to think share prices hit bottom on Sept. 21.”

“Wall Street is nearly unanimous in arguing that valuation models make stocks look cheap. At the recent low, the Standard & Poor’s index of 500 stocks was trading for about 19 times estimated profits for this year, and 17 times forecast 2002 earnings. Given the level of interest rates, most valuation models say prices should rise at least 20 percent to reach fair valuation.”

“The bad news, however, is that those valuation models are based on the last 10 or 20 years — a period without any interest rates as low as the current ones. In 1957, the S.& P. bottomed at less than 12 times that year’s profits. It would be years before the ratio ever got above 20. Investors would have been stunned to see today’s stock valuations.”

“The stock market now is being helped by signs that the economy was not hurt as much as was feared by the terrorist attack. Whether those hopes are justified will become clear in time. But share prices are also being helped by the fact investors find it hard to settle for the safe returns now offered in the bond market.”

“A good-quality five- year corporate bond now yields a little over 5 percent. ‘What’s wrong with 5 percent?’ asks Henry Kaufman, the economist and money manager. He notes that rate is well above the inflation rate.”

“The answer is that memories are different now than they were in the 1950’s. In 1959, people lined up to get a chance to buy the ‘Magic 5’s,’ five-year Treasuries that promised a previously unheard-of 5 percent yield.”

“But 5 percent now seems quite inadequate. To be sure, it is much better than the stock market has done over the last year. But corporations, in calculating their earnings, now assume 8 percent or more in profits from their pension plans. To settle for investments that can’t do that well would mean that they would have to reduce reported profits. Similarly, individuals have based retirement plans on earning a lot more than that.”

” ‘What people have seen, they expect to see again,’ said James Grant, the editor of Grant’s Interest Rate Observer. ‘And what they have seen over the past 20 years is the greatest bull market in the history of the world.’ “