This past week has been nothing short of astonishing in the stock market. Can you believe the volatility? Stock prices seem to be on an emotional rollercoaster. What’s fueling this chaos?
Bill Gross, often referred to as the “Bond King,” has stated bluntly: “The good times are over.” He predicts many asset classes will end 2015 with returns in the negative. According to Gross, declining oil prices coupled with a robust U.S. dollar will restrict the Federal Reserve’s ability to raise interest rates.
We share Gross’s sentiment that 2015 is likely to present challenges for stocks. While volatility was nearly nonexistent in 2014, it has taken center stage this year. The first trading week of the New Year has firmly confirmed this expectation.
For example, the stock market experienced significant declines earlier in the week. The DOW plummeted by 320 points on Monday, followed by another drop of 133 points on Tuesday. However, mid-week saw a shift, with the DOW rebounding by 212 points on Wednesday. By Thursday, it surged again, gaining an impressive 323 points.
As for how the week will end, your guess is as good as ours. By the time you read this, you might have a clearer picture, but we anticipate anything but stability.
Out of Line
There’s something significant at play right now, and many don’t seem to grasp its implications. This situation correlates with Gross’s belief that the era of easy money is ending.
In essence, stock prices have become detached from the real economy, largely due to excessive credit from the Federal Reserve. As a result, they have reached astronomically high levels. The current Shiller price-to-earnings ratio, which reflects average inflation-adjusted earnings from the past decade, stands at a staggering 26. In contrast, the historical median sits around 16.
Historically, such elevated ratios have only been recorded on three occasions in the past 130 years: just before the 1929 crash, prior to the dot-com bust in 2000, and just before the 2007 credit crisis.
Consequently, there are two paths for this inflated ratio to normalize: either corporate earnings must increase or stock prices need to decrease. Regrettably, the latter appears to be the more likely outcome.
Just like trees, stock prices cannot indefinitely soar. Despite the Federal Reserve’s extensive money supply expansion over the past six years, this bull market cannot endure forever. In fact, the more extreme the rise, the more profound the subsequent downturn is likely to be.
A Stock Market Spectacular
Humans have an uncanny tendency to indulge in irrational behaviors that, in retrospect, seem baffling. The frenzied pursuits of beanie babies and tech stocks are merely the tip of the iceberg when it comes to recent market delusions. Nevertheless, nothing ignites a journey toward self-destruction quite like a bull market driven by inexpensive credit.
The allure of inflated money supply often spirals out of control. Historically, following a significant asset inflation, a corresponding panic often ensues. For the past six years, stock values have generally trended upward. However, it may now be time for a downward correction. Here’s the reasoning…
The Federal Reserve’s quantitative easing initiatives are currently paused. Over the past six years, the Fed injected an astonishing $3.5 trillion to sustain financial markets, including the stock market. Without this massive support, the stability of the stock market is increasingly at risk.
Frequent triple-digit fluctuations in the DOW hint that the beneficial phase could be drawing to a close. A healthy market usually doesn’t experience significant day-to-day swings, while a struggling market does—right before it collapses.
As the saying goes, “Easy come, easy go.” The exhilarating influx of capital into the stock market over the last six years could soon yield to a frenetic retreat. Prepare yourself for what’s to come; the spectacle ahead will be nothing short of extraordinary.
Sincerely,
MN Gordon
for Economic Prism
