Great Economic perspective from David Weidner
David Weidner wrote an article today called, Dow 17,000 is on the wrong side of history. It is a must read.
Here is a brief recap…
“But more than any modern bull market, this one stands alone in that it’s squarely out of step with economic growth. It’s being driven higher by just a few wealthy participants and traders who have tacitly, perhaps even unknowingly, agreed to drive prices higher.”
He hits directly at the current nature of the stock markets to be driven by the wealthy. That actually makes the stock market easier to predict. For example, on April 22nd, I said there would be publicity efforts to get the Dow to 16,800. That is the attractor point for the top of the Dow. The Dow moved around that level for a while and then recently made an effort to go over 17,000 right before July 4th. Maybe some people needed extra vacation money. But now 2 days after the weekend, the Dow is heading back down, 16,900 as I write this. Anyway, it is easier to predict the Dow when it is influenced by a greater percentage of the wealthy. Their logic tries to appear complex, but it is simple.
“…the investing public isn’t really buying stocks. A study by the Pew Research Center, published in May, found stock ownership by households is shrinking, at 45%, down from more than 65% in 2002.”
“In all of those periods, the market reflected strong economic trends: solid growth, high or strengthening employment and stable inflation. Only the latter is present today. The unemployment rate is improving, but it’s still a relatively high 6.1%. The best GDP rate produced since the financial crisis was 2.8%. That was in 2012, before the current bull market really took off.”
“Perhaps, as some suggest, this is a new normal. If so, it represents a disconnect between economic reality and market valuation. More likely, it’s a warped market distorted by the extraordinary measures used to create an economic lift.”
Warped defines the market very well.
when you take into account that since the recession, most middle class and working class families have not gotten back into.the market and largely missed out on the bull market and also that the people who have performed best economically since the recession have been the wealthy, it makes more.sense why the performance of the market has outstripped the economy as a whole.
The market is more reflective of the economic situation of those at the top of the economic ladder.
Central banks buying equities for reserves also helps.
The buildup of central-banking interest in equities is one of the unexpected consequences of the last few years’ fall in interest rates, which has depressed the returns on central banks’ foreign exchange reserves and driven them to find alternative investment targets.
In the years since the financial crisis, central banks have leapt to the forefront of public policy making. They have taken responsibility for lowering interest rates, for maintaining stability of financial institutions, and for buying up government debt to help economies recover from recession.
Now it seems that they have become important in another area, too, in starting to build up holdings of equities.
You make a great point.
So in understanding the market, you need to look at other factors apart from unemployment and wage growth. You also need to look at profit rates and consumption by capital income.
The economy is in many ways divided into two sectors… capital and labor. They both experience the economy in two different ways.
Capital is aware of the hidden economic health. Labor is not.
Capital responds to profit rates. Labor only wants a fair share of the profit rate.
Capital consumes when asset prices are rising. Labor consumes when the receive more benefits from work.
Capital from the wealthy benefits from low inflation. Labor benefits from higher inflation. I think Krugman wrote about that today.
Anyway, the stock market does not reflect main street. That is true. Yet, it reflects the other side of the economic coin. Labor being the other side.
To really gauge the health and potential of the economy, one needs to look at both sides of the coin.
You make a great point.
Those articles are interesting. There is pressure within the Federal Reserve system of banks and central banks globally to support stock prices. Yet, stock values are at stall speed.
Central banks should have invested more in main street. Too bad they didn’t.
The Fed does have a program to invest directly into communities, but it almost seems to be at the level of a Public Relations effort.
And with the Community Reinvestment Act, 3 banks have had their strategic plans approved.
GDP may be stagnant, but corporate profits have been going gangbusters because as Edward would point out the high un and under employment has meant wages are stagnant. Thus with the same output profits are greater. The other factor is the old idea of not fighting the Fed. Interest rates are so low that everyone and their sister have been chasing yield and equities are the only place to get any although I read something today about junk bonds and sub prime mortgages making a comeback. If I recall my General Theory, I would argue that we are still in a liquidity trap. Certainly the businesses who can get credit don’t need it and those that could use credit can’t get it.
How would you argue that we are still in a liquidity trap?
Well one could easily argue that cash hoarding is still occurring, and loose monetary policy with very low interest rates aren’t generating large increases in prices, nor was quantitative easing all that effective a stimulus.
The analysis in this post by Jesse Livermore
seems to support the notion that looking to classical economic fundamentals to try to predict market performance may be a fools errand.
The economy is top-heavy with liquidity. There is cash hoarding at high income levels and firms with high profits. Demand is too weak for investment and higher prices. Quantitative easing does not have transmission mechanisms to lower incomes.
We are not in a liquidity trap. Plain and simple, the economy is settling into a new lower normal due to much lower labor share which measures the relative strength of household consumption (70% of GDP).
If potential output was trending back to where it was before the crisis, you have a case for a liquidity trap, but with potential output trending at a much lower level, there is no case for a liquidity trap. Time will show this to be true. We will have to experience viscerally the lower potential output for many economists to understand.
A few problems Edward, a liquidity trap does involve lower output.
In a liquidity trap expansion are monetary policy will not increase output, only expansionary fiscal policy will.
So the fact that the economy is top heavy with liquidity doesn’t disprove the liquidity trap, nor does lower output.
In fact both support a liquidity trap, as does the failure of QE to boost the economy.
What we needed was a strong fiscal stimulus to break the trap
Yet we need not assume that lower output is due to a liquidity trap. I see low output as a problem of effective demand as Keynes pointed out.
As to the other points, monetary policy will not increase output back to the former potential output when effective demand is low.
A strong fiscal stimulus without a greater labor share would have raised capacity utilization and employment to where they are now anyway. The economy would have heated up faster and reached its natural limit sooner.
The effective demand limit that I study has been limiting the businesses cycles over time irregardless of the levels of fiscal stimulus.
To conclude that we are in a liquidity trap now without understanding the impact of effective demand is a hollow conclusion.
The most that we can say is that cash is being hoarded because of low effective demand. So effective demand becomes the deeper cause.
Well, like I said, you have to prove your view of effective demand is correct first.
Currently, there are plenty of other explanations for why output is lower than it should be, including the lack of fiscal stimulus, that don’t require your theory of effective demand limit to be true.
If you can clearly articulate what will happen if your theory is correct (and how it is only explainable by effective demand limit) and that result actually happens, then yes I’ll completely agree with your view.
Heck I’ll contact the Nobel Memorial Committee to nominate you for the prize