Economy makes gains, but fear keeping stock values down. (Up Front).

Whatever explains the sorry state of the stock market, "the weak economy" doesn't do it.

You see the phrase constantly, set against the backdrop of a 5.7 percent U.S. unemployment rate and a gross domestic product growing at a 2.8 percent annual rate. Statistically that's not so weak. It's about average by historical standards. Even if that weren't so, the numbers still wouldn't tell us why the stock market keeps slumping after three straight years of decline.

"There's nothing wrong with the economy," economist Arthur Laffer told financial planners at a T.D. Waterhouse Group Inc. conference in Los Angeles. "The problem is with asset values, which are probably as undervalued as I've ever seen them. Once we get the Iraq thing out of the way, I think we're off and running."

Many times in the past, stocks have prospered in very similar economic settings. This time it must be the vantage point that is different

Look back 10 years to a time when, as today, the U.S. economy was working its way out of a recession. According to my Bloomberg, real (inflation-adjusted) GDP grew 3 percent in 1992 and 2.7 percent in 1993. The unemployment rate at the end of 1992 was 7.4 percent, 30 percent higher than today's.

Discontent with those conditions prompted the American electorate to deny the sitting president, Republican George Bush, a second term, replacing him with Democrat Bill Clinton. Clinton's campaign will forever be known for the rallying cry, "It's the economy, stupid."

Yet the stock market rose in those years. From the end of 1991 through the end of '93, the Nasdaq Composite Index returned 15.1 percent a year; the Dow Jones Industrial Average 11.9 percent, and the Standard & Poor's 500 Index 8.7 percent.

Investors then talked about "Goldilocks" conditions -- neither too hot nor too cold. The economy gave promise of continued growth without overheating, or prompting the Federal Reserve to raise interest rates.

Many of the same things could be argued now, says Jim Thome, who helps manage the $101 million Vision Large Cap Core Fund at M&T Asset Management in Buffalo, New York. "But now we have all this fear," he said.

Plenty: terrorism fears and scandals in "corporate governance," says Jay Mueller, economist and fund manager at Strong Capital Management.

Many people also mention high stock valuations. Lately the price-earnings ratio of the S&P 500 has hovered around 29 times the latest 12-month earnings of its component companies, which is pretty high by most usual definitions. Bloomberg data, however, show 1992 P-B multiples in the 22 to 26 range, not so far from current levels.

"If, as I expect, 2003 is year of trend-like (3 percent or slightly better) growth and low inflation, corporate profits should continue to improve," says Mueller. "That's good news for the stock market."

Why don't stock traders think so? One of the clearer explanations comes from a fund group that has suffered heavy damage from the bear market, Janus Capital Group Inc.

"The economy is still dealing with the consequences of the massive over-investment that occurred in key sectors like technology and telecommunications during the late 1990s," wrote Helen Young Hayes, Janus fund manager and managing director of investments, in a letter to investors. "Ongoing headline risk of Wall Street investigations has created a bunker mentality among CEOs."