Drugged up stock market

October 2nd, 2007

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Ever since Ben Bernanke cut interest rates, the US stock market had been surging, even hitting another record high.

Dear readers, don’t you see something amiss is going on? It had been said that the stock market is an early indicator of the health of the economy. It is very much like the radar of an aeroplane, telling the pilot what dangers are ahead. In fact, the stock market is such a sensitive indicator that its alarms of economic slowdowns often turns out unfounded. Thus, if the stock market is a functional indicator, it should react badly to bad news and react well to good news.

But this is no longer true today. Back in October last year, we already notice this curious phenomena. In Divergent sentiment, we wrote:

So, the stock market is wrong, not because the stock prices rise due to economic growth. They rise due to monetary inflation (printing of money).

There are already plenty of chatters about a looming recession in the financial markets. There has been a steady influx of bad economic news (e.g. sub-prime fall out, deflating house prices, dysfunctional credit market, etc) since we wrote that article. GDP growth in the US is in a downtrend. These are NOT good economic news. Yet, apart from the brief corrections in February and August this year, the stock prices are still climbing upwards relentlessly.

Don’t you find it strange?

Somehow, we have come to the point whereby bad news becomes good news to the stock market. In the minds of the stock market, bad news is good news because a deteriorating economy will induce the Fed to flood the financial system with even more cheap money.

“Hey, why worry? The Fed is shouting as much drinks as we all want [which is infinite by the way]!” the market seems to be saying.

To us, this clearly describes an addict. A drug addict will feel a rush of exuberance when consuming drugs even though they are destroying his/her body. The more drugs one consume, the more one needs them as the addiction imprisons with a stronger and tighter hold. The economy (and by extension, the stock market) is addicted to cheaper and cheaper money. It is such cheap money that got it into trouble in the first place. And now, the Fed is making it clear that they will supply even more drugs… oops, we mean cheap money!

For those who are wise, look at what the US dollar (see What can we expect in a US dollar decline? and One potential trouble-maker to watch out for in 2007) and gold is doing.