Being in a minority is disconcerting, however I would like to state my case regardless, with the hope of challenging a few readers' thought processes. I am of the opinion that money printing is doing very little for the real economy, and therefore-- in the longer term-- will not do much for the U.S. stock market.
I also believe that the various bouts of QE have done little to improve the sustainability of the U.S. public debt. To improve the market, growth needs to be at or above the long term trend. To improve the sustainability of debt inflation, it needs to be higher than we have had for the last 3 years, with growth at the long term average.
The present indicators are that money printing in the U.S. has not produced either inflation or growth.
The chart above shows the rate of growth of retail sales falling over the last 2 years. This will make demand pull inflation unlikely. Cost push inflation is the more likely scenario, if inflation is to take hold. For cost push inflation to take hold, commodity prices and/or wage growth will have to increase.
The chart (above) does not suggest there is considerable cost inflation at the present time, as all sectors are presently falling. We may be fixated on oil prices presently, but apart from oil, the graph does not show large input cost inflation.
So what about wage inflation. Wage inflation is presently 1.7% annually, close to where it has been for the last 2 years. With commodity prices reasonably stable and wage growth of 1.7%, the present environment is not inflationary.
Therefore, I would suggest that the the growth of money is the reason that commentators and the markets are betting on higher inflation. Let's now have a look at these data points.
M2 has surged 10.1% in the last year. The size of this increase is inflationary if the velocity of money and the money multiplier just stay constant, let alone rise. However, if velocity and multiplier are falling, the extra money in circulation is unlikely to cause inflation.
The velocity of money has fallen 5.3% in the last year. It has been falling since the start of the credit crisis in 2007. The present rate is the lowest it has been since the 1960s. Let's now move on to the money multiplier to see if this is signaling any inflation.
This is a little more problematic-- for the year as a whole it is down 5.7%, however for the last 7 months it has rebounded strongly. I would comment that this series has been in decline since the mid 1980s. Therefore it appears unlikely that this will last (but it is possible).
For inflation to take hold, due to the surge of the M2 money supply, both velocity of money and the money multiplier will need to stay constant. This is not the case at present, although the current surge in the money multiplier is worrying. I would contend that the various rounds of QE have so far not produced an inflationary environment. The velocity of money and the money multiplier are the missing link. Until these 2 metrics change, inflation will not take off despite any commentary suggesting otherwise. Good commentary can be backed up by data suggesting a high probability of the suggested outcome. In this case, the present data does not support higher inflation.
There is one last data point that I would include, and that is the value of the U.S. dollar.
The graph (above) is for the dollar index. The index has stopped falling, stabilizing between 72 and 90 over the last 3 years. One of the greatest pushes to a country's inflation rate is if the currency is falling. However, since 2008 this is not the case in the U.S. This will make inflation less likely to increase in the future. Whilst global economic tensions are still so high, I think that a fall in the dollar is highly unlikely. QE is supposed to produce a fall in the currency, but this is not happening in the U.S. economy. Inflation seems to be reasonably low and stable.
I wrote a piece here on the chance of U.S. long term growth, so I will avoid repeating it here. I would just add to that the growth rate for the economy for the last 3 years, since the credit crisis began (shown below)Click to enlarge
does not support the theory that QE is increasing growth. Real GDP was 3.0% in 2010 and 1.7% in 2011. This is despite various QE episodes that started in 2009 and ended in 2011. QE has been in operation for most of the time from the start of the credit crisis, but so far it has not produced sustainable growth. You may argue that growth would have been lower without QE, but based on the evidence it is difficult to argue that QE is producing sustainable growth.
I am a believer that the long term growth of earnings is what drives the stock market. Ultimately earnings growth goes hand in hand with growth of real GDP in the economy. If QE is not producing lasting gains in either growth or inflation, I cannot see why at least a few commentators are not questioning the worth of QE and the fact that it is not producing results. This would lead to a realistic view on its effect on the market.
At present there is an unshakeable embedded belief that QE (or money printing by any of the central banks) will goose the markets. Maybe I am early with this call, or maybe I am wrong. However, the earnings growth for the S&P500 for the 4th quarter 2011, with 454 of the companies having reported is as follows:
Earnings Growth: The blended earnings growth rate for Q4 2011 is 5.9%. The Information Technology (13.5%) and Industrials (12.6%) sectors have the highest growth rates for the quarter, while the Telecommunications Services (-28.2%) and Materials (-13.7%) sectors have the lowest growth rates.
The S&P500 is up 9% for 2012, so unless earnings growth accelerates from here you are relying on p/e expansion for further gains in the market. It is clear that the money printing is driving the market gains, but is not feeding into the real economy. How much longer can this situation last? If popular opinion starts to question the results of money printing, I would suggest 'not for very much longer'. Alternatively, I could remain a minority and the market will march higher to the tune of increased money printing!
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: long RWM, short S&P500 futures
Disclaimer: This article is not intended as investment advice. Before taking any action, please do your own research. Do not rely on any opinions or facts included in this article for decision making.