What’s Really Propelling the Stock Market Higher

Consumers are back at it…doing what they do best.  They’re buying stuff and they’re consuming it.  Moreover, they’re doing so at an accelerating rate.

The Commerce Department reported on Wednesday that retail sales increased 1.1 percent in February, the largest rise since September, and well above January’s 0.2 percent gain.  This is in spite of the 2 percent increase in payroll taxes and the tax increase on the rich.  Apparently, so far, smaller paychecks are not inhibiting people’s desires to spend money.

This increase in consumer spending should help the first quarter GDP number, since consumer spending makes up about 70 percent of the U.S. economy.  But is an increase in GDP, propelled by an increase in consumer spending, really a good thing?

If the increase in consumer spending is funded by savings and capital investment it is.  Unfortunately, this increase in consumer spending is supported by an increase in consumer debt.  This will have a lasting impact on future economic growth.

In short, people are borrowing today to pay for things they haven’t yet earned.  Tomorrow they will still be paying for these things, rather than buying new ones, which will be a long term drag on the economy.

Consumer Debt on the Rise

The way things are going, the increase in retail sales reported by the Commerce Department is a proxy for rising consumer debt.  It is a measurement of the rate the collective consumer is taking on debt.  If this goes on long enough, like in the years leading up to the 2008 debt crisis, consumers will all go broke together.

From what we gather, they are trying their darnedest to all do it again.  According to recently released Federal Reserve data, U.S. households increased their borrowing at a seasonally adjusted annualized rate of $312 billion during the fourth quarter of 2012.  This is the biggest increase in household borrowing since deleveraging was forced upon the economy by the Great Recession.

Obviously, households are no longer deleveraging…they are leveraging.  What’s more, they are continuing their borrowing spree into 2013.  Additional Federal Reserve data show consumers increased their debt at a seasonally adjusted annualized rate of 7 percent in January.

No doubt, the lessons consumers learned from the recession were short lived.  They’re eager for the good times to return.  They are spending as if they already were here.

But perhaps they are right.  Perhaps the economy’s turned around.  Based on the stock market’s recent activities, times couldn’t be better…

What’s Really Propelling the Stock Market Higher

Yesterday the Dow did something it hasn’t done in over sixteen years.  For 10 consecutive trading sessions, it went up.

The last time the Dow had a 10-day run was November 1996.  Between November 4 and November 15, 1996, a total of 10 trading days, the Dow closed higher each day…rising from 6,023 to 6,348.  This amounted to a gain of 5.4 percent.

Over the subsequent 10 trading days, from November 18 to December 2, 1996, while the Dow didn’t increase each day, it did still gain 2.7 percent over this period.  During this latest run, the Dow rose from 14,054 on March 1 to 14,539 on March 14, 2013, closing higher each day…for a gain of 3.5 percent.

Clearly, stocks are having a fantastic run.  Year to date, the Dow is up 10.7 percent.  But something doesn’t quite feel right about it.  What’s going on?

One thing that’s going on is the increased use of debt to buy stocks.  This is called margin and it involves borrowing money from a broker to buy shares of stock.  Steve Keen, author of the book Debunking Economics, says the ratio of stocks purchased on margin is now 70 percent.  In other words, with $300,000 you can borrow $1 million worth of shares.

Keen believes there’s a relationship between the change in margin debt and the level of stock prices.  Moreover, he believes there’s a correlation between the acceleration in margin debt and the rise in stock prices.  If Keen is correct, and we have no reason to believe he isn’t, the rise in stock market prices is being propelled by accelerating margin debt.

In other words, stocks are rising on pure price speculation.

Keen has also noted that margin debt levels in the U.S. are now similar to where they were in 2000 and 2007.  If you recall, those periods were just before the stock market crashed…and margin calls rang off the hook.

Sincerely,

MN Gordon
for Economic Prism

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