GDP down, unemployment claims up, unemployment rate up, Dow heads for record high … say, what?

Many folks are wondering: Why has the stock market continued to steam ahead despite a ho-hum (or humbug) economy?

Source: Council of Economic Advisers

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.

Hmmm.

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.

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