Stock Market

There He Goes Again…

By Michael Coolbaugh  |  November 14, 2019

If you’re an active investor, it’s easy to be consumed by economic data. Makes some sense, though…

As the economy oscillates between recessions and expansions, it stands that the stock market should follow.

I’ve touched on the importance of being able to identify where we stand within the business cycle and its implications for performance across sectors within the stock market. But here’s an old Wall Street adage that I learned years ago: “The stock market is not the economy.”

I don’t know if anyone really knows who this can be attributed to. But the saying is just about as old as the agreement signed by traders under the buttonwood tree.

And, for the most part, data like the ratio of the stock market to gross domestic product (GDP), supports this statement.

So, when it comes to investing, this is important to remember.

Especially when Jerome Powell says to the U.S. Congress, “Nothing booming in the economy that would likely bust.”

Here’s My Issue with That…

A statement like this is equivalent to an arsonist telling us not to worry about the can of gas in his hand because he’s yet to strike the match.

David and I, on numerous occasions, have outlined that monetary policy has not had a significant impact on the real economy.

In fact, the harsh reality is that financial assets have been the main beneficiary of such out-of-control monetary policy.

Unfortunately, for some reason, central monetary planners believe that financial assets, or more specifically, the stock market is the economy.

But if you asked me to show you one piece of evidence, and only one piece of evidence, that monetary policy has not had its intended influence on the “real economy,” it would be this one right here…

You see, the prices of real assets relative to prices of financial assets have plummeted to a level never before seen throughout recorded history.

Put very simply, financial assets have outperformed real assets.

You know, the materials required to build stuff, the materials we would expect to perform well along with a recovering economy.

Not by a little bit… not by a lot… but by astronomical amounts…

Where Am I Going with All of This?

Well, one of the many unintended consequences of such reckless monetary policy is that we run the risk that the stock market becomes the economy.

What do I mean by that?

It means that back in 1792 under that buttonwood tree, the economy influenced the stock market.

But today… well, it’s the exact opposite.

In fact, it can be argued that the two most recent recessions in 2001 and 2008 were caused by a collapse in some form of a financial asset.

You see, as an economy becomes increasingly financialized – meaning it is ever more reliant on rising financial asset prices – the more sensitive it becomes to swings in those asset prices.

Here’s A Fun Tidbit to Demonstrate…

A couple days ago, Bank of America Merrill Lynch published its monthly survey of fund managers from around the world. This month’s survey found was that global optimism rose by the most in the history of the survey. In fact, investors have done a complete 180-degree turn in sentiment.

And, so, the news stories ran…

Here’s MarketWatch: ‘Fear of missing out’ triggers huge fund manager shift from cash to stocks, Bank of America Merrill Lynch says…

Here’s Yahoo! Finance: Fears of a nasty US recession have magically vanished: BAML survey…

But what’s changed?

Economic data hasn’t improved. The Trade War hasn’t been resolved. Brexit negotiations haven’t progressed. Earnings of major international corporations continue to fall. And unrest in the Middle East is still alive and well as Israel is showered with missiles.

In other words, not much…

But here’s the kicker. Not only have the S&P 500 Index, the Dow Jones Industrial Average, and the Nasdaq Composite all hit new all-time highs. So have numerous equity indices all around the world.

As for the old adage “the stock market is not the economy,” well, it appears that still holds true today as financial assets continue to diverge from economic reality.

But with a record percentage of net worth tied to financial assets, we run the risk that the stock market may, once again, become the economy.

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