Stock Market Bubble

By Dave Cantey 2013 11-17-13

All the Certified Financial types (Planners, Advisors, Analysts, etc.) have passed various licensing exams to prove that they have drunk the cool aid of Modern Portfolio Theory. Modern Portfolio Theory (MPT) purports that stock market behavior is a random walk. Although we can prove mathematically that this is not the case, academic orthodoxy demands acceptance of their Random Walk Hypothesis. (Our model is based upon old fashioned supply and demand, involving funds flow rates). Like many other academic hypotheses, evolution for example, any evidence to the contrary is utterly rejected by academic theoreticians. Pity. Within MPT, the stock market valuation model is dependent primarily upon earnings and growth rates (PE), as a predictor of stock prices. Unfortunately, for the licensed practitioners, the real world rarely behaves in this way. Right now, the macro economy is growing at about 2% per year, and has been growing at this slow rate for some time. Yet, the stock market is up 28% so far this year (roughly 30% annualized). This compares with an historic average growth rate of about 3% for GDP, and about 7% for stocks per year. Using the MPT valuation model, one cannot come close to justifying a 30% stock market growth rate this year. Subpar GDP along with stocks growing 4 times greater than average should be setting off alarm bells everywhere, but the investment professionals arent even blinking an eye at the obvious bubble currently being inflated in stock prices. What is causing the bubblebuilding growth in stock prices this year? Answer: The Fed. The graph shows the money printing explosion that is driving stock prices higher. Recall that the top 1% own about 50% of all stocks, and that the top 20% own over 80% of all stocks, so all this money printing benefits only a small portion of the overall population (the super rich), but OH, HOW THEY BENEFIT! Isnt trickle-down economics beautiful? Its really too bad that trickledown doesnt actually create jobs, or trickle down money. Maybe it should be called, gush-up economics! Neither Congress, nor the Fed, nor Regulators, nor Wall Street apparently have any trepidation about either this disparity in benefits, or the obvious bubble that is currently being created. During Janet Yellens testimony last week before the Senate, when asked about financial bubbles, she, like all her predecessors, responded that the Fed (including their 250 in-house PhD economists) do not know how to identify bubbles as they are inflating. Seriously, can they really be this blind? Folks, yours truly can see a bubble forming. Can you see it? This isnt rocket science.