Stocks are more than double from the previous bubble. I’m a poet, and I didn’t even know it.
It seems that the U.S. stock indexes are hitting new all-time highs virtually every day. If you put money into an index fund in March 2009 and held it until today, you would have done very well.
But I don’t want to compare stock prices right now to what they were in March 2009, which was the low point of the great recession, at least for stocks.
I want to compare today’s prices with what they were when the good times were seemingly roaring. The Dow Jones Industrial Average hit a high of 14,164 on October 9, 2007. As I write this today (December 27, 2019), the Dow closed at 28,645. That is just over double in about 12 years.
The S&P 500 hit a high of 1,565 on October 9, 2007. Today, the S&P 500 stands at 3,240. Again, that is more than double from its previous bubble peak.
The Nasdaq hit a high of 2,811 on October 10, 2007. That was its high for that cycle. It had hit a high just above 5,000 in the technology boom/ bubble of the late 1990s and early 2000. The Nasdaq stands today at 9,006. It is not quite double what it hit 2 decades ago, but it is more than 3 times what it was during its 2007 peak.
The numbers are obviously more stunning when you compare today’s levels to what they were in 2009. But there was major panic at that time, as the country saw the worst financial crisis since the Great Depression. Stocks probably sold off more than what was justified.
But obviously there was a major bubble in stocks in 2007. The big drop did not come until later in 2008. It is a good lesson that the bursting of a bubble can start somewhat gradually at first.
Does anyone really think that stocks should be worth twice as much as what they were worth in 2007? Does anyone think they are worth 4 to 5 times what they were in March 2009?
Of course, they are worth what they are worth on the open market. But are the valuations justified? And what portion should we attribute to the great inflation that took place after the financial crisis began?
Inflation and Stocks
I have long maintained that monetary inflation is the main reason that, broadly speaking, stocks rise. Sure, individual stocks go up and down based on earnings and other factors. But as a whole, the stock indexes go up and down largely due to monetary policy.
If there were a fixed money supply, stocks would not likely go up (again, as a whole) over time as they generally do now. You would invest in an index of stocks in order to get dividends from the earnings. The main goal would not be capital gains, if at all.
But in our world today, it is one of central banking and fiat money. And with this, there is mostly monetary inflation. This is why stocks generally go up over time, in spite of the wild volatility on a shorter-term basis.
The Federal Reserve nearly quintupled the adjusted monetary base from 2008 to 2014. However, with fear in the market, coupled with the Fed paying interest on bank reserves, much of the newly created money did not get lent out. This helped contain consumer price inflation.
Consumer price inflation, as measured by the Consumer Price Index (CPI) has been relatively stable since 2008, running around 2% per year. This still depreciates the money you hold in your pocket (or bank account), but it is mild as compared to what could have happened.
Prices in assets have not been as tame. Housing prices have certainly risen again in most areas, although not necessarily to the same degree as in the 2000s. But the obvious asset price inflation has happened in stocks, which does not get reflected in the government’s CPI calculations.
As investors search for yield, especially with low interest rates, the newly created money has been used to bid up stock prices.
Unfortunately, many people gauge the health of the economy with the performance of the stock market. There is certainly a correlation, but we have to be careful in distinguishing correlation from causation.
A recession is a correction of the misallocated resources. The misallocation has already happened. While unemployment is low, many people are struggling. They feel like their cost of living is going up faster than their wages, and they are probably correct.
A correction (if allowed) is necessary to realign resources in accordance with consumer demand. When the correction becomes apparent, stocks will likely fall. But it doesn’t mean that everything was great up until the peak of the stock market. The misallocations had already happened. Investors dumping money into stocks was part of that misallocation.
The crazy rise in stock prices is largely due to monetary inflation. It isn’t because so many companies have become so much more profitable. Stock prices have gone far beyond the rate of inflation. This is especially true if we measure stock prices against consumer price inflation.
When the recession hits, we may actually see mild price deflation for a short period, although this won’t last long as the Fed is likely to step in quickly with more digital money printing. The deflation in asset prices will be far more severe. The higher they go, the harder they fall.
Conclusion
Stocks have more than doubled from the bubble of 2007. If they plummeted from the 2007 levels, what will happen at the December 2019 levels, which are far higher?
To ask the question seems to answer it.