Last week was filled with awful reports about the state of the U.S. economy. But the stock market went up three percent. Why?
The stock market is supposed to be a barometer of the overall economy. It’s supposed to go up when economic times are good and fall when they aren’t. This barometer has never been perfect in this regard, of course. Market-specific quirks such as the recent leverage buyout craze can skew that relationship for awhile. These days, however, the schism between market direction and overall economy has a more fundamental and perhaps more long lasting cause. Manipulation by the Fed.
The manipulation at work here isn’t the Bear Stearns variety. It has to do with interest rates. Something almost unprecedented is happening with these rates today. Government securities, and the many fixed income ones (bonds, CDs, etc.) liked to Federal rate setting, are paying less than the inflation rate. (I speak here of the real world inflation rate, not the phony one favored by the Fed that excludes the costs of food and energy.)
What this means for investors large and small is that they can’t buy safe interest-paying securities as a defensive measure to protect their capital.
Such purchases actually lose real world value when inflation growth outpaces these traditional safety nets. To get ahead with investments, even to remain at the same place in real terms, means you have to leave the realm of safety and seek higher returns elsewhere.
Like the stock market. Which is where more investors are now fleeing in this quest with infusions of funds in spite of the fact that the assets being purchased (pieces of publicly traded companies) are often losing real worth as the overall economy declines.
That’s why the stock market is going up even while economic news gets worse by the day—more money chasing the same number of stock shares. And for awhile the worse news gets (higher inflation, more Fed interest rate cuts) the more incentive the could be to buy stocks. At some point, though, were this trend to go on too long, inevitable nasty social consequences will even reach the other-worldly confines of the stock market.
But not to worry when that happen. The clever lads and lasses who now so blatantly shape our personal financial futures will almost certainly find a way to finesse the situation.
Of course they will. Who could possibly think otherwise?