The Dow Jones Industrial Average made another concerted run at the elusive 27,000 milestone over the last several weeks. But, as of this writing, the index has stalled out short of this psychosomatic barrier. By our estimation, this is for the best.
While not always apparent, the stock market generally maintains a loose connection to the underlying economy. Over long multi-decade periods, as measured by the price-to-earnings (P/E) ratio, it will undulate between stages where it’s cheap and stages where it’s dear. Eventually, however, the stock market reverts towards its mean P/E ratio – always overshooting and undershooting as it cycles about.
One of the unintended consequences of fiscal and monetary intervention is that it distorts this relationship. Stimulus intended to juice the economy has the effect of juicing financial markets. Sometimes these inflationary policies have the effect of completely disconnecting the stock market from the economy.
For example, Venezuela’s Caracas Stock Exchange, Stock Market Index, has soared over 36,000 percent in the past year alone. Yet no one, save President Nicolás Maduro, would point to the booming Caracas Stock Exchange as an indication of a healthy and sound economy. In truth, the Caracas Stock Exchange is a barometer of the country’s insane economic policies.
Hence, after a decade long bull market in U.S. stocks, one that’s pushed the P/E ratio to nosebleed valuations, we find comfort and relief in a sideways or falling stock market. Perhaps the U.S. stock market is not entirely rigged after all. Perhaps it’s only partially rigged.
Still, we have some reservations…
Devising a System of Chaos
When Alan Greenspan first executed the “Greenspan put” following the 1987 Black Monday crash, financial markets were well positioned for this centrally coordinated...