The reason stocks are going up... - The Daily Reckoning
The Daily Reckoning by Bill Bonner
On This Day - 15 May 2013
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Baltimore, Maryland

Whoa! Investors are acting like it was 2007 all over again.

USA Today has the story:

    NEW YORK - Emboldened by soaring stock prices and record-low borrowing costs, stock investors are taking out loans against their portfolios at the fastest pace since before the Great Recession hit.

    So-called margin debt hit $379.5 billion in March, the highest level since July 2007 when such debt hit an all-time record of $381.4 billion, according to the most recent data available compiled by the New York Stock Exchange.

    The trend signals that investors are more comfortable with stocks and are more willing to use borrowed money to buy more securities in hopes of garnering fatter returns in a hot market that has pushed the Dow Jones industrials up more than 15% in 2013.
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Why are investors so bullish? Because the economy is coming back? Because the future is rosy? Because stocks - whose earnings are already in record territory -- are going to earn even more?

Nah...what do you take us for, dear reader? We know the story. Stocks are going up because the Fed is making them go up. Here's David Rosenberg in Canada's 'Financial Post:'
    The U.S. Fed has always been important in influencing trends in the financial markets, even if the economic effects have been far less than dramatic. This influence has actually strengthened in recent times to the extent that the correlation between the Fed's balance sheet and the direction of the stock market, which was barely 15% before all these rounds of quantitative easings began four years ago, is 85% today.

    By way of comparison, the time-worn correlation between the market and corporate earnings has remained unchanged at around 70%.

    The Fed is trying to bring the overall cost of capital down to a level that would be consistent with a - 2.2% Fed funds rate, which is where the rate actually should be based on current inflation and the still-huge amount of excess capacity in the economy.

    But the funds rate has been at zero for more than four years. The Fed cannot magically create a negative nominal interest rate, so it is using the powers of its balance sheet to achieve the same result.

    This then brings me to my very last point, which is what I think was a critical inflection point when the Fed said in its December post-meeting press release that it will not budge from its 0% policy rate until the U.S. unemployment rate drops to 6.5%. It is currently around 8%.

    We have done estimates based on various assumptions and found that achieving this Holy Grail likely takes us to the opening months of 2018 or another five years of what is otherwise known as financial repression.
But wait a minute. If the Fed continues goosing up stock prices for another 5 years, isn't that going to put stocks in 'irrational exuberance' territory? Won't artificially low interest rates - over such a long period - create the same sort of distortions and bubbles that led to the crisis of '08-'09 in the first place?

Well...yes...of course.

But the Fed is on the case. It says so right there in the paper. The Fed governors "are considering an exit strategy." Exit from what? They are trying to figure out how to get down.

For 4 years they have been climbing up and up -- offering loans at negative interest rates... trying to encourage people to borrow and spend. They want people to part with their money, not save it. And they've also given the economy more money - QE 1, QE 2, and now QE 3. In the current version of QE, they print up an extra $85 billion a month and pump it into the banking system.

That money hasn't done much for the real economy - the unemployment rate has gone down, but only because people have left the workforce - but it's done wonders for stock prices. The Dow has more than doubled since '09. It's up this year too - hitting record after record.

Ben Bernanke says he wasn't targeting equities with his QE program. But that's what he hit...climbing higher and higher to get a good shot. Now, he's sitting on top of a monetary pile that is 4 times as tall as it was in '07.

And now, how will he get the Fed down without getting hurt? If stock prices are so closely correlated to Fed money-printing, won't stock prices go down if they turn off the presses? And how will the Fed react when it sees stocks go into another major bear market?

Our guess is that as soon as Bernanke hints at cutting off the presses, stocks will begin to slide. Then, when the presses really stop, they'll fall hard. That's when it will get interesting. If the Fed can't cut back now...how will it do so when the markets and economy are even more dependent on it?

Instead, the Fed will panic...and climb even higher.

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

Disclaimer:
The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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1 Responses to "The reason stocks are going up..."

Borkar M.R.

May 15, 2013

Fed is creating a dangerous situation. As stated in this article, if people r borrowing to buy stocks and when market falls, as it is bound to in a year or two, as the energy blcak hole sucking colapses on its own weight, what will happen? As farmers in Maharashtra commit suicide, there will be wide spread wave of suicides,arson, loot and murders. The clamour for rate cut in India and RBI's reluctance to oblige this demand is correct course. It is MAY,let us get out of market, at least partially. I am doing this selectively and in small lots "before irrational exhuberence hits the masses". - Amen

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