On Wednesday, the Wall Street Journal published an opinion piece by Rich Karlgaard, the publisher of Forbes, titled "The Stock Rally That Isn't." It seems that Mr. Karlgaard has a very similar view of the current "stock market rally" that I do.
Basically, the stock market rally that Mr. Obama is taking credit for is nothing more than the another cycle in the sideways movement of the stock market since 2000. Mr. Karlgaard writes, "Now stocks are flirting with all time highs, up 88 percent since Mr. Obama took office and 124 percent since the lows of March 2009."
But, take a look at the accompanying chart.
Although the S&P 500 index is flirting with all time highs, the stock market has been moving basically sideways since the year 2000 and the range the market has been trading in has been relatively consistent. The question always is, what might cause investors to break out of the trading range and move the market on to new highs?
I don't like to base all my argument on historical patterns, but as Mr. Karlgaard points out, the previous period of sustained growth in the stock market, which took place in the Reagan, Bush (41) and Clinton years, began in 1982 and ran until 2000, a period of about 18 years. The previous period of sideways movement came in the 1963 to 1982 period, basically the Kennedy, Nixon/Ford, and Carter years. This can be seen in the chart.
Although not shown here there was another sustained period of stock market growth that took place in the previous 15 years, basically the Truman, Eisenhower years. If this pattern holds, then the sideways movement in the stock market should continue for another three to five years. But, is there any economic explanation for this stock market behavior?
Mr. Karlgaard provides two economic reasons for these movements in the stock market. I summarize the economic reasons into just one explanation.
Mr. Karlgaard argues that the difference between the various periods is defined by what is happening to the value of the US dollar and by the strength of economic growth. In the periods where the stock market is moving sideways the value of the U.S. dollar is declining and economic growth is relatively tepid. In periods when the stock market is growing, the value of the U.S. dollar is rising and economic growth is much more robust.
For example, by the end of the 1963-1982 period the United States had floated the U.S. dollar, the government had frozen wages and prices, and the economy was in a period of stagflation. From 1974 to 1980 the stock market had risen but only by 103 percent.
in the 1982 boom, Mr. Karlgaard states the S&P 500 rose by 1,194 percent. During this time period the value of the U.S. dollar was strong and economic growth averaged 3.6 percent.
During the Obama presidency, the stock market has risen by 88 percent, although as can be seen by the chart, the S&P 500 index has peaked out around 1,500 since 2000. During this time period, except for occasions when international investors moved funds into dollars as a risk-avoidance action, the U.S. dollar has declined. Economic growth has been around 1.5 percent
I have consolidated Mr. Karlgaard's two reasons into one: credit inflation. During the Truman/Eisenhower period, the government deficit was extremely low, monetary policy by William McChesney Martin was controlled, and inflation was extremely modest. In the early part of the 1982-2000 period, Paul Volcker kept monetary policy very tight to bring down the double digit inflation that was present in the latter part of the 1970s and Treasury Secretary Robert Rubin oversaw the government budget go into a surplus.
In the 1963 to 1982 period, greater and greater deficits were accumulated in the federal budget and in the 1970s monetary policy was run to get President's elected or re-elected. From 2000 to the present, federal deficits have been excessive, reaching in excess of one trillion dollars a year over the past four years.
Overall, except for the very tight money under Paul Volcker and the movement into a fiscal surplus under Rubin, the period from 1961 to the present can be considered the age of credit inflation. The number one economic goal of the government during this time has been to try and keep unemployment low. This has meant that the tools of government, monetary and fiscal policy, would always been available to underwrite more economic stimulus to keep unemployment at relatively low levels.
Thus, with the exceptions mentioned above, the primary policy of government was to see that credit was created in the U.S. economy. The annual compound rate of growth of government debt since 1961 has been in excess of 7 percent. The annual compound rate of growth of private debt since then has been over 12 percent.
This credit inflation, over all this time, has been translated into a decline in the value of the US dollar. The only exceptions we have seen to this decline have been in the periods when real efforts have been made to try and defend against this credit inflation.
One can see the results of this in the stock market. When credit inflation was under some kind of control, the 1982-2000 period, economic growth was solid and the dollar was strong. During the 1963-1982 period and the 2000 to the present period, economic growth was less than desired and the dollar was weak. I don't see economic growth picking up or the S&P 500 breaking out of the present range until something is done about the credit inflation now taking place.