A Stock Market Spectacular

What a week.  Can you believe it?  Stock prices have gone bipolar.  What is going on?

According to “Bond King” Bill Gross, “The good times are over.”  He’s predicting “minus signs in front of the returns for many asset classes” by the end of 2015.  Gross also believes falling oil prices and a strong U.S. dollar will limit the Federal Reserve’s ability to raise interest rates.

Like Gross, we believe 2015 will be a rough year for stocks.  Where stock volatility was minimal in 2014, in 2015 price volatility will be the norm.  The first full trading week of the New Year confirms this insight.

For instance, during the first part of the week stocks were down…a lot.  On Monday the DOW fell 320 points, and on Tuesday it fell 133 points.  By mid-week stocks were up…the DOW jumped 212 points on Wednesday.  Then, yesterday, the DOW jumped another 323 points.

Your guess is as good as ours as to how the week closes.  You may have some indication by the time you read this.  Our guess is that it will be anything but stable.

Out of Line

Something very important is going on.  Most people don’t seem to have much of an inkling of it.  Nonetheless, this likely has something to do with why Gross believes the good times are over.

In short, stock prices have been disconnected from the real economy by an abundance of Federal Reserve credit.  They’ve also become very expensive.  The current Shiller price earnings ratio, based on average inflation adjusted earnings from the previous 10 years, is at 26.  The historic median for the Shiller PE Ratio is about 16.

This ratio has only been higher at three times over the last 130 years: (1) Just prior to the 1929 crash. (2) Just prior to the dot com bust in 2000. (3) And just prior to the credit crisis in 2007.

Naturally, there are only two ways for today’s doublewide ratio to come back in line.  Either corporate earnings must rise or stock prices must fall.  Unfortunately, it’ll most likely be the latter.

Stock prices, like trees, don’t grow to the moon.  Even with the Fed’s mass inflation of the money supply over the last six years this bull market cannot last forever.  Moreover, the further and faster it rises the more epic the bust will be that follows.

A Stock Market Spectacular

No doubt, man is prone to flights of fancy, which, in hindsight, are beyond comprehension.  Mad dashes for beanie babies and dot com stocks merely scratch the surface of recent delusions.  But for love and war, there’s nothing that softens the minds and warms the hearts of men to self-destruction than a cheap credit induced bull market.

The magic of money supply inflation has a knack for getting away from itself.  Like all experiments with paper money and central banking, following a great asset inflation there is a great panic.  Over the last six years stocks have generally gone up.  Maybe it is now time for stock prices to go down.  Here’s why…

The Federal Reserve’s quantitative easing program is currently on hold.  If you recall, over the last six years the Fed created $3.5 trillion to prop up financial markets…including the stock market.  Without this massive support, the stock market could become wobbly and topple over.

The daily triple digit swings in the DOW are an indication the gig may be up.  A healthy market doesn’t swing wildly about from one day to the next.  But a sick one does…just before it goes caput.

Easy come easy go, right?

The exhilarating rush of money into the stock market over the last six years will be followed by a violent stampede back out.  Pull up a chair.  Grab a fresh bucket of popcorn.  What is coming will be spectacular.

Sincerely,

MN Gordon
for Economic Prism

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