Inflation May Be Poised to Pop Stock Bubble

The Slow-Motion Train Wreck of Market Mania and Inflation

Bullion.Directory precious metals analysis 20 August, 2021
By Peter Reagan
Financial Market Strategist at Birch Gold Group

Taken together, these are a reliable indicator that Wall Street isn’t thinking clearly. Optimists persist in the delusion that the stock market party is going to continue forever.

Wall Street already dodged one bullet they didn’t even hear fired:

Corporate profits have roared higher in such a spectacular fashion that those valuations — when analyzed against the actual earnings reported a year later — were almost 20% cheaper than analysts thought when investors began piling into the S&P 500 Index in April 2020.

Do you see what happened? Investors piled into stocks that, in hindsight, turned out to be cheaper than they thought. Remember, this was a strange time. Many states were paying unemployment payments to workers stranded at home, so it makes sense that money was being spent freely (in a “hyper-speculative,” “blindly courageous” mania).

We’re using the word “mania” deliberately here to describe irrational behavior based on hope. Those who bought into the post-pandemic bounce did so not based on fundamental analysis, but rather on speculation that Fed Chair Jerome Powell wouldn’t let the stock market collapse.

And, upon reflection, we can see they were right.

You’d think that would be enough. But it’s not. As Edward Chancellor’s masterpiece of financial speculation Devil Take the Hindmost points out, a gain in the stock market generates a positive feedback loop that encourages additional buying, and even attracts new money off the sidelines (“emulation of one’s neighbor, and the credulity of the crowd”).

This credulity, this belief that stocks somehow can’t go down, is at an all-time high:

At 21 times forecast earnings, the S&P 500 indeed sits near the highest multiple since the dot-com era. But what if those profit estimates are too low this time, too? [emphasis added

Here’s another, from Ben Carlson: “there are good reasons for the overvaluation in the U.S. stock market right now.”

Irrationally hopeful views abound. “The market is siding with the bullish view.” Sounds exciting, maybe even patriotic somehow. Optimism is, after all, a virtue.

Here’s the real problem: once you’re inside the bubble, you lose your perspective. From the inside, it’s not a bubble anymore. It’s just business as usual.
 

Optimists aren’t blind, but they still can’t see

John Hussman’s recent analysis summed up the optimist psychology nicely:

Every speculative bubble convinces investors that the world has changed in ways that make basic arithmetic irrelevant.

You can see that the Buffett indicator points toward froth rather than a reason to be bullish. According to this indicator, the stock market is trading at twice its average market value. A 50% crash in prices would bring it back to the long-term trend.

That seems more like a bubble getting ready to pop than a once-in-a-lifetime change in fundamental values.

There’s the P/E Ratio Model, which reveals an economy heading for “1999 dot-com bubble” territory, which is not something to be optimistic about.

The dispassionate can reflect on market history and understand that reversion to the mean (also known as “the law of financial gravity“) always and inevitably drag sky-high prices back to reality.

It’s not the dispassionate who are most at risk, though.

Ultimately, we don’t know when the stock market party will end. We don’t know what will trigger the first exodus. What we do know is that retail investor spending has been behind this “hyper-speculative,” “blindly courageous” market bubble.

Therefore, anything that puts pressure on retail investors, everyday folks like you and me, is bad news for stock prices.

And that’s why persistent high inflation is a warning…
 

Next stop, reality: The Fed’s inflation train has left the station

The FOMC meeting from July 27-28th has generally produced nothing new, according to recently released minutes.

In fact, the Fed could be so committed to the same course they’ve been following that monthly minutes were mostly copy/pasted from the last meeting. This is happening in spite of the obvious consequences, like red-hot inflation that hasn’t slowed down since January 2021.

Powell claims that the Fed will continue to “closely monitor the situation.” That likely means they’re not going to raise rates anytime soon, and will probably continue the quantitative easing program.

Those steps are liable to drive Powell’s “transitory” inflation “blip” into double digits. That means less money for retail investors to shovel into the stock market. And it also means less spending which has driven those corporate profits so high over the last year and a half.

In terms of headlines, you’ll hear a whole lot more about new all-time highs in stocks than on CPI. Part of the persistent mania mindset is to focus on good news, and ignore the bad. To focus on today’s Dow Jones Industrial Average numbers than on the price of a gallon of gas.

That single-track mindset doesn’t care if a gallon of milk costs $8. In fact, according to a recent report, some economists think we should be paying more…

Starting with proposals to lift the 2% inflation target: “Many top economists have argued the Fed should take the next step and lift the target permanently.”

And the same Fed economists propose that inflation should keep heating up:

two former senior staffers at the U.S. central bank argue that continued higher prices in the future may be what is needed to shift the whole economy to a higher plateau and deliver a jobs boom that helps the broadest set of people.

So, after all this time, inflation was the cure, not the disease?

Listen: a “jobs boom” sounds great. We don’t think it should come at the cost of permanently high inflation. Who cares how high the economic plateau is if we have to work three jobs just to pay the bills?
 

Protect your savings from market bubbles and inflation

While the Fed’s pet economists try to convince us that “inflation nation” is a great place to live, it’s up to us to stay grounded in reality.

When you’re preparing your financial plan for the next decade, look for opportunities to diversify with inflation resistant assets. That’s one way to create a foundation for your savings that won’t evaporate no matter how high and hot inflation burns.

Review your risk profile and make certain you’re comfortable. Consider diversifying with physical precious metals as part of your financial plan.

It’s comforting to know that, when you really need the money to be there, you can have confidence that the “store of value” gold and silver can deliver. Especially in uncertain times.

This article was originally published here

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