Two Charts to Explain Why The Market Keeps Moving Higher in Spite of a Weak Economy

The Federal Reserve Bank of St. Louis has a website that is an excellent source of data and graphs.


Nicknamed "FRED" (for "Federal Reserve Economic Data"), the site provides "154,000 economic data time series from 59 national, international, public, and private sources" which is more than enough to satisfy even the most wonkish analyst.

Here's the link:

http://research.stlouisfed.org/

FRED was recently updated, so I spent a little time this weekend on the site looking at some of the charts.

Here were two that caught my eye.  In my opinion, they provide most of the explanation for the apparent disconnect between anemic economic growth and the relentless rise of the stock market.

As we all know, the Federal Reserve has been aggressively adding monetary stimulus to the economy.  This chart illustrates just how large the stimulus has been in the past few years:


If you look carefully, you can see the Fed has added almost $4 trillion to monetary stock since 2009. This is roughly the same amount that the entire M2 money supply had reached in the year 2000.

Unfortunately for the economy, most of this monetary stimulus has been squirreled away.

The velocity of money - which measures how the rate at which a unit of currency is used to purchase goods and services within a given time period - is at all-time lows:

 

In times gone by, money added to the economy would have spent on consumption and investment, which would eventually lead to stronger economic growth and more employment.

However, these are unusual times.  Instead of leading to an uptick in the economy, the Fed's increase in money supply is being simply added to the bond and stock markets.

Yields remain low, stock prices move higher, but the real goal of the Fed's activities (economic growth) is not being achieved.

"Secular Stagnation"

 

http://ftalphaville.ft.com/2013/11/18/1696762/summers-on-bubbles-and-secular-stagnation-forever/?ftcamp=crm/email/20131118/nbe/AlphavilleNewYork/product

The economics world is abuzz about a speech that former Treasury Secretary Larry Summers gave at an IMF Research Conference on November 8.

While I don't typically recommend talks by economists, this one might be worth a view.

Summers points out that real GDP growth has been essentially stagnant for the past few years, and unemployment remains unacceptably high, despite massive monetary stimulus attempts by the Federal Reserve.

Could it be, Summers asked, that the U.S. is mired in a period of "secular stagnation"?

Moreover, while he acknowledges that the Fed's actions staved off economic disaster in 2008, what tools would be available if another crisis were to arise?

Here's Paul Krugman writing in this morning's New York Times:

Mr. Summers began with a point that should be obvious but is often missed: The financial crisis that started the Great Recession is now far behind us. Indeed, by most measures it ended more than four years ago. Yet our economy remains depressed. 

He then made a related point: Before the crisis we had a huge housing and debt bubble. Yet even with this huge bubble boosting spending, the overall economy was only so-so — the job market was O.K. but not great, and the boom was never powerful enough to produce significant inflationary pressure. 

Mr. Summers went on to draw a remarkable moral: We have, he suggested, an economy whose normal condition is one of inadequate demand — of at least mild depression — and which only gets anywhere close to full employment when it is being buoyed by bubbles. 

I’d weigh in with some further evidence. Look at household debt relative to income. That ratio was roughly stable from 1960 to 1985, but rose rapidly and inexorably from 1985 to 2007, when crisis struck. Yet even with households going ever deeper into debt, the economy’s performance over the period as a whole was mediocre at best, and demand showed no sign of running ahead of supply. Looking forward, we obviously can’t go back to the days of ever-rising debt. Yet that means weaker consumer demand — and without that demand, how are we supposed to return to full employment? 

http://www.nytimes.com/2013/11/18/opinion/krugman-a-permanent-slump.html?ref=opinion&_r=0 

In other words, what if there are secular causes behind our current period of economic stagnation that government policies can do very little to address?

There's lots to ponder from this short talk.

For investors, however, one possible conclusion might be that the widely-held assumption that interest rates and inflation are inevitably around the corner might not be as obvious as most assume.