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I've posted on this subject before, and it remains a very important issue. Since last March, the dollar has weakened considerably and equities have enjoyed a powerful rally. (Note that the red line, the dollar, has an inverted scale, so a rising red line means a weaker dollar.) It's also the case that growth in M2 has been flat since March, growth in dollar currency has slowed considerably, and commodity prices have surged over this same period.
All of these developments are intertwined, and they tell a convincing story. The single thread that ties these things together is rising confidence. The world is regaining the confidence in the future that it had lost going into March. With rising confidence, the demand for money has declined. Since the Fed has boosted the available supply of dollars, but the demand for them has dropped, it is only logical that the price of the dollar should fall. With rising confidence, people are beginning to spend the dollars that they had been hoarding, and the economy is reviving. With an abundance of dollars in the world (and on the margin an increasingly excess supply of dollars), people are converting unwanted dollars into commodities and into stocks.
The Fed is getting what it has been trying to achieve. Cash that pays a zero yield only makes sense if you are terrified of all the alternatives to cash. Once you become less terrified of the future, your natural inclination is to shed cash, and/or borrow dollars, putting the money to work in gold, other currencies, commodities, houses (yes, this helps explain the surge in existing home sales that was reported today), gold, and equities.
We're talking tidal forces here that are shifting beneath the surface (a good analogy to come up with while sitting on the beach in Maui). They are very powerful, they move slowly, and they are almost impossible to stop.
And it doesn't hurt that Obama's plans for the future are being derailed. The expected future size of the government is much less today than it was back in March, and consequently expected tax burdens are much less. This adds to confidence; what is bad for Obama is good for the market.
6 comments:
I want to thank you for your blog. I read many blogs, and find their overwhelmingly bearish tone to be a result of ideology or in-the-box fundamental analysis.
I am very long this market and thank you for adding to my confidence in the equity situation.
For sure Burt, Scott was very early to call the recovery. Also, Scott you were early in your call for inflation risk from the excess supply of dollars. If inflation emerges, I imagine the market will decline based on the expectation of rising interest rates and the deficit spiraling out of control.
If this happens the dollar may rise, Robert Prechter has predicted a rising dollar. Also, the increase in the percent of bulls is a good contrary indicator suggesting the markets could reverse.
Ronrasch, what you say could well happen. But I don't see trading on that now. For the time being most people I know are still missing the key current macro stories: liquidity and the decrease in depression-like levels of risk aversion.
Thanks, Burt.
Scott,
What are the chances that we are repeating a 1930 market scenario where the market went way up only to really crash in 1932? Could all the doom and gloom about commercial real estate loans that are about to go into default cause this?
I think the chances of that are pretty low. The major causes of the Depression were 1) contractionary monetary policy, 2) sharply higher tax rates, and 3) the Smoot-Hawley tariffs which spawned a global trade war. None of those problems exist today. Indeed, monetary policy is aggressively accommodative, taxes are set to rise only marginally over a year from now, and global trade is rebounding.
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