Stimu-less?

“Who goeth a borrowing
Goeth a sorrowing.”
—Thomas Tusser

What’s Really Moving the Stock Market?

The answer isn’t obvious at first glance. Some say the economy is recovering, and businesses are doing better. But we also notice weak jobs data, growing federal and state deficits and declining tax revenue – along with a real estate market facing more serious challenges ahead. The real question may be – why after $trillions of government stimulus, does the stock market seem to be indecisive at best – and perhaps teetering?

A Revealing Chart

It’s long been our opinion the sharp increase in assets prices – from stocks in the 80′s and 90′s, real estate during the past decade, followed by stocks again in 2009-2010 – have been fueled largely by an ever-expanding money and credit supply.

The chart below may show the recent stock market gain may not be an indicator of economic recovery, but instead – something else.

Source: FMGR

One can clearly see the correlation between the upswing of the S&P 500 Index and the Federal Reserve Bank’s purchases of US Government Debt – i.e. “quantitative easing” (also known as “money printing”).[1] Through quantitative easing (QE), the Fed creates money out of thin air – buys government debt – watering down the Dollar your savings are denominated in in the process.[2]

Looking at the chart it is clear the S&P 500 began its “recovery” in early 2009 when the Federal Reserve began Quantitative Easing (QE).[3] The chart also shows the S&P dropping in early 2010 when the Fed stated it would end QE.[4] We didn’t believe the Fed could end QE for long (because in our opinion the likelihood of a deflationary downtrend would increase) – and others may have agreed since the S&P rallied again.[5] But the Fed did in fact take its foot off the money printing pedal (at least for now) – and the corresponding recent drop in the S&P 500 is evident in the chart.[6]

What’s Next?

Our regular readers know we’ve long been of the belief the US (and world) economies have, to a great extent, been driven by expanding money and credit for decades. It’s our belief that if the Fed steps out of the way, no longer funding stimulus and bailouts with newly created money – a great regression to the mean likely awaits. In other words, deflation. The contraction of money and credit. Falling prices and increasing purchasing power for the Dollar. We believe such a drop in asset values would be quite steep because they’ve been driven up for such a long time by money printing.

Do we think Fed Chairman Bernanke will stand idly by and allow such a deflationary collapse? Our answer is “no.” We believe he and his predecessor Alan Greenspan have already shown their true colors. It’s our opinion the Fed will print like mad – and politicians (who want to get re-elected) will let it happen. The last thing an increasingly indebted government wants to do is pay $trillions back in stronger dollars.

So we believe more (and more) stimulus lies ahead – paid for by ever-increasing amounts of money created out of thin air.

And we continue to prepare for the opportunities we believe lie ahead.

While there is a lot of tough reality going on out there – we maintain our positive outlook. That outlook is based on our belief that a bear market in one thing is often a bull market in another.

As we enter this critical time – now, more than ever – we believe investors need to focus on their investment strategies. Those readers who are clients are fully aware of the strategies we’re implementing in light of unfolding economic circumstances. Others may feel free to contact us to learn more.

Sincerely,

Stephan R. Ernharth, JD
Vice President
Ernharth Group
www.ernharth.com

Go to www.ernharth.com/economic-commentaries to read past articles from our Economic Commentary series.

1.FMGR; “A Signal From the Stock Market”; June 14, 2010
2.Ibid.
3.Ibid.
4.Ibid.
5.Ibid.
6.Ibid.