Frank Shostak of the Mises Institute has written a piece on how easy money drives the stock market.  He points out that history shows an increase in the money supply generally precedes a rise in the stock market.

Conversely, a decline in the growth of money generally precedes a drop in the stock market.  He goes back as far as the 1920s and uses the big stock crashes in American history to make his point.

At the end of his article, he suggests that the stock market (he uses the S&P 500) is highly vulnerable because of the fall in liquidity from June 2009 to June 2010.

As noted in Shostak’s article, there is usually a time lag, typically longer than a year, as it takes time for the change to filter through the system.  However, if he is marking June 2010 as the end of a big fall in liquidity, then a 6-year time lag seems awfully long.

But this ignores QE3, which was the Fed’s biggest and longest round of monetary inflation.  The Fed created about $1 trillion in 2013 alone and slowly wound it down in 2014.

We must remember that the Austrian Business Cycle Theory says that you do not necessarily have to have a declining money supply, or even a stable money supply to have a bust.  If the rate of growth is decreasing, this can be enough to expose the malinvestments and bring on a bust, or at least the popping of bubbles.

Even if the rate of inflation stays stable, say at 20%, you will eventually get a bust.  The only way to prevent the bust is by continually increasing the rate of the growth of money.  Eventually, this leads to hyperinflation, which is the biggest bust of all.

I believe that if the Fed had stabilized the monetary base a few years ago and kept it that way, thus having no QE3, then we would have already seen a major bust.  But QE3 was enough of an injection to stall the bust.  Of course, it will also make the bust worse when it eventually does come.

We must also remember that we have already seen oil fall to below $50 per barrel.  There has been a bust in the oil market, which just so happens to be good for most consumers.

Overall, I am in general agreement with Shostak that there is a stock bubble that has been fueled by the Fed.  With its current stable money policy, the bubble in stocks is quite vulnerable.

I advocate a permanent portfolio for a good portion of your investments, which will include 25% in stocks.  But outside of this, and perhaps a few speculative plays in mining stocks, I would avoid stocks right now.  If you are feeling particularly courageous, you might even consider a small short position at this point.

The Austrian Business Cycle Theory tells us that a bust is coming, unless the Fed decides to ramp up its digital printing press again, which seems unlikely right now.  I think a big downturn in stocks is more a question of when at this point.