Many folks are wondering: Why has the stock market continued to steam ahead despite a ho-hum (or humbug) economy?
Answer: It’s less a matter of optimism re: a recovery, and more a function of the Fed pouring money into the economy. You know, quantitative easing — QE-infinity.
Here’s why …
Historically, the relationship has been oft demonstrated: increase the supply of money and stock prices increase.
The effect is amplified this time around since the money isn’t flowing into hard assets (houses, capital equipment) … it’s going disproportionately into financial assets.
And, since the risk-return ratio is so unfavorable in many asset classes (think bonds yielding negative real rates of return) … the stock market gets most of the Fed’s added money.
As long as the Fed keeps pouring money into the system, the stock market will do ok … when the Fed throttles back, it’s likely to be ugly.
None of this is “new news”.
In fact, back about 40 years ago, an economist-wannabe co-authored a study in the Journal of Finance titled The Supply of Money and Common Stock Prices.
The article summarized an econometric study that demonstrated a tight link between the amount of money floating around and, on a slightly time-delayed basis, the price of stocks.
OK, fast forward to today.
Now, when the Feds expand the money supply, it’s called “Quantitative Easing” … or QE, for short.
Recently, Jason Trennert of Strategas Research Partners published a revealing chart that visually relates stock prices (the S&P 500) to the recent periods of quantitative easing.
Looks like the supply of money and common stock prices are still related.
Partially explains why the Dow is over 14,000 despite a sluggish and uncertain economy.