Stock Market Loves Bad Economy Update
Some months back I pointed out that while the financial media was attributing the stock market rally to optimism regarding an incipient rebound in the economy, the rally was not behaving in a way to support that theory. In fact the stock market was rallying particularly strong on days when the financial rebound looked the most in jeopardy or some dire financial news was making the headlines.
I was not surprised when the market rallied on bad economic news because the reasons for the rallies were actually supported by a sluggish or stagnant economy. This is still the case and as I mentioned then the only way this rally ends is through another financial crisis or the economy truly begins to rebound and heat up.
The current source of corporate and investor profits is not in business expansion or in a rebound in consumer spending, but rather in low interest rates and easy money. This explains why the market rallies on bad economic news, for as long as the economy is stagnant interest rates will stay low and stimulus plans will be in the making. A rebound in the economy would cause a steep increase in inflation which would force interest rates back up.
A rise in interest rates would cause a substantial increase in the amount of money being spent by government, businesses and consumers on the massive debt they have amassed. With low interest rates corporations and investors can continue to make more money on investments and longer term bonds then they have to pay in interest on their debt. This profit through borrowing is the main driver in the year long stock market rally and the growth in earnings being claimed by corporations.
Corporate profits are growing due to technical financial reasons rather than business expansion and growth. A business which is borrowing money at historically low interest rates is able to claim earnings and profit growth by simply downsizing and hoarding the money.
When overhead goes down profits generally go up. So if your firing people, finding cheaper labor overseas and not using your profits to build or expand your business, you are able to claim substantial earnings growth. You can then use that positive report to coax investors to buy more of your stock which in turn gives you more cash to hoard and claim as profit and earnings. Not only that, but you can then borrow additional money at ridiculously low rates and make money by buying a stock market which is rising almost daily. The Nasdaq 100 is leading the way and has gone up over 90% in then last year.
A substantial portion of the money being infused into the market is borrowed money. Many investors are borrowing money to specifically use in the market. They use the profits from their trades in an ever rising market to pay off their loans and then borrow more money to put in the market to take advantage of this perpetually rising rally.
None of these profits are dependent on the economy actually rebounding,. in fact the whole chain of borrowing and investing is being driven by low interest (borrowing) rates, which in turn is dependent on a stagnant or sluggish economy.
This borrowing low and using the money for the purchase of higher interest bearing financial or rising stock prices is very similar to the “flipping” of houses mania that existed right before the real estate crash. Flipping as you recall was the purchasing of a home and then immediately selling the property for a profit in an ever rising market.
Like the real estate market, this current investment mania will end very badly. Yet, like the real estate fiasco, many of those who most abused the system will walk away wealthy and unscathed while then small investor while get crushed when the market crashes or once again have to pay for others mistakes through future bailouts or just paying off others debts as taxpayers. The hope is that the stimuli and cheap money along with the market rallies will finally succeed at providing the means and confidence to fuel an actual economic rebound. Yet, when the methods of benefiting from economic stimuli, bailouts and low interest rates are hoarding, borrowing and flipping stocks it is hard to imagine the economy being resurrected by these devices.
In fact, if my analysis is correct, the means of acquiring wealth in this environment is the largest obstacle and hurdle we face when trying to create an economic rebound. In this environment true business growth and expansion would force interest rates up resulting in not only the borrowing supporting corporate and investment profits from drying up, but make payment on their mountain of debt impossible.
How far can this rally go? I guess at least as high as a condo in Florida could have before the real estate crash. Are we there yet? I have no idea, but it won’t take long to see it when it happens.
Until that time comes just sit back and watch the stock market spike every time the Federal Reserve gives any indication that they plan on keeping interest rates low for “the foreseeable future”.
Jim Guido