A Kamikaze Stock Rally?

A temporary economics victory could prove very costly...

THE S&P 500 made another all-time closing high yesterday, writes Daily Reckoning Australia editor Dan Denning.

The US big cap index closed at 1594. All ten sectors in the index closed up. But over the last year, there have been some clear leaders (with tech stocks being the laggards). The leaders represent the global blue chip 'fortress of wealth'.

For example, take Johnson and Johnson (NYSE:JNJ). The company makes lots of products you'd recognize, like Listerine mouthwash, Tylenol, Sudafed, and Pepcid AC. But it's really a small country masquerading as a big company. It's a post-modern nation state without entitlements or a standing army.

JNJ is made up of over 275 operating companies in sixty different countries. It has 146 manufacturing centers, dozens of products, $239 billion in revenues in 2012, and over 128,000 employees. Its shares have also doubled the performance of the S&P 500 in the last twelve months.

You'd have to look at the balance sheet and the cash-flow statement to determine if the share price performance was related to the strength of the business. But you could easily argue that companies like JNJ are the leading beneficiaries of quantitative easing. It doesn't have a generous dividend yield. But for investors looking for 'safe' blue chips, it's a good fit.

But this could be part of the kamikaze rally as well. Investors have come to believe that stocks will always be lifted by central bank bond purchases. We suggest this belief is similar to the Japanese belief that divine Providence favored their island when confronted with foreign threats.

Two Mongol invasions — the first in 1274 and the second in 1281 — were repelled, in part, by typhoons which swept away Mongol invasion fleets. The 'divine wind', or kamikaze, that whipped up the storms was, of course, the name given to the tactic of suicide bombing by airplane in the Second World War. In the battle of Okinawa in 1945, Japanese kamikaze attacks sunk at least 20 US naval vessels and damaged 157 others.

In today's terms, the kamikaze rally is the rise in the stock market you get from currency depreciation/debasement. This kind of victory-through-weakness is every bit as destructive, in the end, as the kamikaze attacks. The 'victory' is the rise in stock prices and the temporary boost in exports from countries that debase first and fastest.

The weakness is the eventual currency crisis that results. Ordinary people lose purchasing power as imports cost more. Any temporary boon to stock prices is wiped out as low interest rates and inflation destroy middle class savings.