A Market Driven by Illusion

Two different readings of stock market history...

AS NEAR AS we can tell, stocks have been driven up by the Fed's EZ money. Investors expect more EZ money. So they think stocks will go up more, writes Daily Reckoning founder Bill Bonner.

We are attending an investment conference in New York. What has struck us so far is how optimistic the young investors are. They think stocks always go up.

'I'm 36 years old,' one explained. 'That means I was too young to get in on the boom of '82 – 2000. All I've seen are stocks going up and down. They're just a little bit higher today than they were in 2000 — when I was just 23 years old.

'But when I look back on the history of the stock market, what I see is a market that takes big leaps forward...then we get a period in which prices don't go anywhere...and then we get another big leap ahead. I want to be sure I don't miss that next big move to the upside.'

His reading of stock market history is much different from ours. What we see is a market that, in inflation adjusted terms, goes up...and then goes down. It can go up for decades... and down for decades.

The next big move to the upside might not begin for another five to ten years. In the meantime, investors could lose half or two-thirds their money.

Then again, there may never be another major bull market cycle for all we know. The bull market of the '50s and '60s was based on growth and output expansion. The bull market of the '80s and '90s was based on credit expansion.

What will drive the next bull market? Growth has slowed to a crawl. Credit cannot expand forever. Are the big bull markets over?

We don't know. But we wouldn't stake our financial futures on catching the next one anytime soon.

'But stocks have been going up since 2009,' replied the young man. 'Companies have record profits. There are lots of new technologies and innovations coming online. I don't see any reason for this bull market to end. It could go on for many years.'

Yes, it could.

But this is a market driven by illusion...we explained. It's an illusion created by phony money.

'Aw, c'mon...the Fed's new money is just the same as the old money.'

Well, yes...and no. Each of the old Dollars represented a certain amount of goods and/or services. That amount was measured by the 'price' of things.

Now, the Federal Reserve is adding more Dollars — at a rate of $85bn per month. Other central banks are doing the same...with the Bank of Japan (BoJ) leading the way. The BoJ is adding, proportionately, much more money that the Federal Reserve.

At the same time, the economy is NOT adding anywhere near as much in terms of goods and services. Real private sector output is about the same today as it was ten years ago.

This is what makes this new money much different from the old money. It comes with no new output behind it. So, it will inevitably and eventually have to come to bear on existing output...not new output.

The only result can be higher prices. How much higher? No one knows. It depends on the velocity of money...which depends on how the economy is doing...and how eager people are to get rid of their Dollars (that is, on their perception of the quality of their money).

One way or another, the Dollar will be worth less than it is today. How much less? Only time will tell.