How Have U.S. Stocks Defied Gravity for So Long?

by: Peter Cooper

This Tuesday will mark the anniversary of last year’s US stock market low. Since then the market has rallied by 70 percent in a recovery only slightly less suspicious than a Madoff hedge fund.

A year ago uncertainty hung over the Dow and S&P 500 with the possibility of an economic depression and the potential nationalization of the entire banking system. But what has happened since then did not fall so far short of this extreme.

The Great Recession

The economy has undergone its biggest post-war contraction and unemployment has soared to 15 percent, including the long-term unemployed. With 36,000 jobs lost last month this rise might be slowing but it is not yet decisively over.

Meanwhile the ‘too big to fail’ banks like Citibank (NYSE:C) remain effectively nationalized, although a great deal of the emergency facilities granted to the banks have been withdrawn.

But bank lending is still seriously down on a year ago and the credit crunch remains a reality for millions, not least of whom are the several million home owners with mortgage resets that will land them in foreclosure over the next couple of years.

Housing sales and auto sales – the two biggest drivers of the US economy – remain deep in recession, not to say depression – as they have fallen into a trough from which it is hard to see a way out. There is no catalyst for a recovery or one on the horizon, indeed quite the reverse for housing in particular.

Market Manipulation

We are indebted to some of our loyal readers for providing an answer to the conundrum of why the stock market has recovered so dramatically when the reality of the economy has been so weak. To quote from a recent article on by Tyler Durden about the fourth quarter of last year:

Anyone looking at their 401(k) portfolio performance since the end of August will undoubtedly be very happy (and extremely surprised), as the market has climbed steadily higher despite i) increasingly declining trading volume and ii) consistent and material withdrawals from domestic equity mutual funds.

Furthermore, if anyone was merely looking at the trading action in regular hours, one would think there was absolutely no profit made since early September. The reason for that: all the upside since September 14th has come exclusively from after hours action.

Every single day, minimal volume pushes the futures index higher. Good news, bad news, it don’t matter to the Goldman S&P and Russell 1000 futures desk: they just lift every micro offer, giving the impression that the market is unstoppable, often leapfrogging each other as the latest viagra’ed GDP or unemployment rumor is spread.

Come morning, it is time for the HFT brigade to come in and scalp their trillions of pennies while leaving the market unchanged, then at 4pm handing it off again to leveraged futures manipulation and dark pools. In a nutshell, this is the secret of the past quarter’s phenomenal market performance.

So this is what has fooled us, and we are humbled! Perhaps we should have expected this with the benefit of hindsight. The largest Fed intervention in markets in history could hardly take place without doing something equally big in the stock market. Why should market forces be allowed to work for equities and not bank liquidations?

Looking forward, however, what the Fed has created is another huge bubble in US stock market valuations. Not only are stocks expensive given the reality of the economy. They are also being artificially inflated in value by outright manipulation aided by the cheap money doled out to investment banks.

Dividend Suppression

That is why the market will allow dividends to persist at an average of two percent while the long-term average dividend is double that amount – implying that share prices should be half what they are today. It needs little imagination to see what must happen in the near future: the mother of all corrections.

Of course timing such a crash is very tough. The manipulators will want to do it to suit their purposes. For example, if they wanted to sell a lot of bonds and were finding it difficult then a nice stock market event would power the bond market back up – perhaps into its final bubble spike?

Short covering might drive the stock markets a little higher this week but staying on the short side is the only viable strategy as a preparation for what is to come.

What goes up has to come down, and the higher you go the harder you fall!

Disclosure: Author holds a short position in the S&P

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