Stock Market Vulnerability Grows

Stock prices around the world have been on a tear since bottoming last March.  Support has mostly come via the denominator effect; central bank currency depreciation.  If for instance a currency loses half its value, it takes twice as much to buy the same stuff.  The price doubles even as value stays the same.  Stock prices are no more exempt from inflation than anything else; they merely tend react earlier than most other prices.

So why might stock price inflation not continue?  All that is required for stocks to rise arbitrarily high is for the pricing unit to fall sufficiently low.  But so can the prices for other things … like bread, houses, cars, gasoline, lumber … 

Inflation is fun, as long as it mostly affects the prices of things we own, like stocks or even houses.  When it affects the prices of things we buy, not so much.  And that’s been happening for the better part of a year.  Now it’s becoming recognized as “inflation” … it’s been around for a while but only recently it’s making headlines.

The Federal Reserve has been actively inflating stock prices for over a decade.  It’s been largely free of public pressure to abstain mostly because most people don’t mind rising stock prices.  But now that other prices are rising even faster, the Fed doesn’t have quite the free hand it did.  With inflation making headlines, if stock prices dive, it has become much harder for the Fed to ride to the rescue.  How could it justify cutting interest rates or ratcheting up money printing even higher when inflation itself has become the main worry?

This situation is not without precedent.  Back in the runup to 2008, rising prices forced the Fed to raise rates.  Oil prices notably reached $147 a barrel in June of that year.  Stock prices had already peaked in October of the previous year and we’re in a bear market, but the obvious inflation problem kept the Fed from countering with easy money.  Stocks went into free fall by October 2008. 

The current juncture increasingly resembles the 2008 setup.  The main difference is that the Fed has not been actively tightening policy.  But it may be sufficient that it’s constrained from further loosening; asset values are much higher and the economy more hobbled by government intervention.  None of this requires that stocks decline, but the Fed put investors have been counting on for years wouldn’t stand in the way.

 

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