I’ve received several emails lately that cite the stock market’s recent surge as evidence of the long awaited economic rebound. Is this a valid argument? Not necessarily…Here’s why.
Stock prices are based on a number of factors that are indirectly related to the economy. In theory, a stock’s value should reflect the expected short- and long-term earnings of a firm, but many investors buy stocks simply because they believe their value will rise more than other investments. Put another way, I might not like GM as a long-term investment but I might purchase the stock if I believe others will do so, which would drive up the value of my investment in the short run.
Others might invest in the stock market if they don’t like the available alternatives. After increases in gold and silver prices for the last several year, many investors have pulled back for the time being. The Fed also manipulates the stock market, and has recently sold naked shorts of gold to both drive the price down and profit from the decline. With the Fed keeping interest rates (artificially) close to zero, fixed term investments offer returns below the expected rate of inflation, prompting even conservative investors to buy more equities.
My point here is that the stock market is driven by many factors and should be considered one indicator of an economy’s health. In my view, the U.S. economy is in a holding pattern, and many companies are beginning to adjust to the new normal of increased regulation, government influence, and Obamacare. This, combined with economic weakness in many other countries, has primed the stock market as well. Many firms appear to be sidestepping increased hiring costs by getting by with fewer employees, which is why the U.S. workforce is shrinking.
A modest rebound is not out of the question, but my long-term outlook for the economy remains grim. Trillion-dollar deficits are expected for some time and many in Washington are still calling for more taxes and government spending. Entitlements are out of control and any serious reform is unlikely to pass while Obama is in office. Even with some gains in the stock market, another financial crisis is inevitable if we don’t change course. The only question is when.