Liquidity Driven Stock Rally-Again
"Stocks have been on a run recently on hopes that the worst of the credit crunch is over and on expectations that the Federal Reserve will keep cutting interest rates."
But if the worst of the credit crunch is over, the Fed isn't likely to cut interest rates. Good thinking, Beavis.....
It was seemingly puzzling because the day featured only bearish news, such as earnings warnings for Citigroup and UBS and a weaker than expected ISM manufacturing index. Yet even though there was only bearish news-the stock market rose more than 1%. What's up with that?
The reason why the stock market rose yesterday is basically the same reason for why it has risen more than 10% since mid-August. It is also the same reason that explains why the dollar has dropped roughly 5% and commodity prices risen more than 10% during the same period. The explanation spells massive monetary expansion.
If you adhere to the narrow money supply definitions of Frank Shostak and his followers, such as Mike Shedlock and Gary North, these movements would indeed seem unexplainable, as M1 actually fell more than 1% between August 6 and September 17. It is also down 0.1% compared to the same period last year.
However, if you look at MZM, it is up 3% in that same period, which is equivalent to an annualized increase of 29.2% and up 11.8% in the latest 52 weeks. Similarly bank lending is up 2.1%, or 19.5% at an annual rate (some "credit crunch"), and up 11.6% in the latest year.
This again illustrate that not only is MZM better than M1 from an essentialist point of view, it is also far, far better in explaining economic trends in general and financial market movements in particular.
Given the extremely loose monetary conditions, it seems possible and even likely for the U.S. stock market to continue to make new highs for a while. However, I don't think the rally will continue for much longer. Because first of all, most stocks are very expensive from a fundamental point of view. Stocks are up more than 16% in the latest year even though earnings are likely to be up only 5-6% (official estimates point to 3%, but as they are always beaten we should add a few percentage points), so they are in fact roughly 10% more expensive. Stocks are arguably more overvalued now than at any time in history except for the late 1920s and late 1990s.
Moreover, contrary to Wall Street expectations the Fed's room to cut interest rates is limited as even official consumer price inflation is likely to rise sharply. They will probably still cut in the next meeting, but after that, the surge in inflation will tie their hands.