“If something cannot go on forever, it will stop.” ~Herbert Stein
We are in the midst of an unprecedented stock bubble. After almost a full year of various lockdowns and business restrictions, along with multi-trillion dollar deficits and higher unemployment, stocks are booming.
The stock boom would be almost ridiculous during a time of prosperity. Given what has happened in the last year, it is beyond ridiculous.
The young adults who have taken their stimulus checks and started a Robinhood account are going to learn a hard lesson about bear markets, at least for the many who do not cash out while the going is good.
The stock bubble is built on Federal Reserve inflation. The Fed’s balance sheet continues to explode. By the time March gets here, it will have close to doubled.
There is a disconnect between price inflation and the Fed’s balance sheet. Likewise, there is a disconnect between price inflation and stocks.
The latest CPI numbers show the CPI in January 2021 rose at 0.3% over the previous month, and it rose 1.4% year-over-year. The more stable median CPI rose 2.1% year-over-year.
Perhaps these numbers are understated. But they aren’t so understated as to not recognize a disconnect. Stocks are going to the moon. Real estate, especially in the suburbs, is mostly going up fast. Consumer prices on everyday goods are not going up fast.
In the short time it took the Nasdaq to go from 10,000 to 14,000, I can tell you that my grocery bill did not go up by 40%.
Uneven Inflation
When the Fed creates money out of thin air, prices tend to go up. In some cases, especially in today’s technological world, some prices go down. Given the Fed’s inflation, they go down less than they otherwise would have.
There are other factors, particularly the velocity of money. If people are not spending a lot (i.e., not bidding up prices), then this will tend to push prices down, or at least keep them from going up as fast as they would have.
When there is monetary inflation, it takes time to go through the economy. A good analogy I read once was comparing it to pouring pitchers of molasses into a bathtub. I believe it was Richard Maybury who wrote this. He said that there are cones of molasses in certain spots that are much higher. It takes time for it to flatten out.
So it is with price inflation. Prices don’t rise simultaneously. Over time, it tends to even out. Some periods take longer than others.
Right now, there is a giant glob of molasses that represents stocks and real estate. If the Fed keeps pouring massive amounts of molasses in the bathtub, then maybe the stocks and real estate won’t go down. But the most likely scenario is that the Fed won’t be able to pour enough in fast enough to stop it from sinking to other areas.
Therefore, depending on how fast the Fed can pour its molasses (create money out of thin air), either stocks and real estate are likely to come down, or other consumer prices, especially necessities like food, are likely to go up in price.
This is why we have to diversify. We don’t know which way this is going to go in the short run or the long run. Will we see stocks crash? Will we see other prices spike higher? Will we see both and then a reversal of one or the other?
At some point, something has to give. We are either going to get significantly higher price inflation, or we are going to get a major crash in stocks. It is amazing that things have gone on this long.
However, I will keep in mind what Keynes supposedly said. The market can stay irrational longer than you can stay solvent.
The market is already irrational. Is the Nasdaq going to double over the course of a year, in one of the worst economic years ever in modern times?
I remember the exuberance of 1999 and 2007. I remember the downfalls in 2000 and 2008. 2020 and 2021 will be memorable too.
I don’t know when the crash will happen, but it is going to be swift and hard when it does. And if the Fed starts pouring buckets of molasses to stop the deflating stock bubble, then we are likely going to see massive price inflation at some point.