When Less Money Starts Chasing More Shares, Stocks Will Drop

For anyone who owns stocks, 2013 has been a great year. For everyone else, the economy sucks. In 2013, the US stock market soared 30% and Exchange Traded Funds that invest in companies shrinking the number of shares rose over 42%.

What is more, I think stock prices will continue to bubble up through at least the early part of January. That is not because the US economy is growing sustainably. Rather, stock prices will keep rising near term because lots of new year end money will be going into US equities. Yes, the Fed will start tapering by $10 billion per month. The impact of less new cash plus the annual end of January resurrection of the new offering calendar could end the five year bull run. Why? Simple. More shares chasing less cash.

Long term viewers of this site know that stock prices in aggregate go up or down based solely upon the interplay between supply and demand of shares of stock and money available to buy shares. Historically there is no evidence demonstrating a causal relationship between earnings growth and future stock prices.

So even though earnings are not related to stock prices over the long term, over the short term most investors will get fully invested if they believe that a currently accelerating US economy will justify even higher stock prices. But when the reality of no sustainable economic growth sets in – at the same as the Fed reduces the amount of money it creates to buy financial assets by $10 to $20 billion per month – stock prices will plunge.

So, here are the four reasons why many believe the US economy is sustainably growing and why each assumption is wrong.

The first is and has been housing. Starting last spring when mortgage rates made all time low. The economic bulls, including this week’s Barron’s say that the housing market will continue to improve. Their evidence, the seasonally adjusted garbage survey data by the US Census Bureau. However, real time data from housing market trackers report that sales rates in many of the recently booming markets such as Las Vegas, Phoenix and California’s Central Valley are plunging and are actually down year over year for the first time since 2009.

Mark Hanson at MHanson.com says that the housing bulls are seriously missing the fact that the monthly mortgage payment for buying a $300,000 house today is now higher than buying a $400,000 house during the mid 2000s bubble. Why is housing affordability way down? Simple, very few homes in 2005,6 and 7 were sold with a fixed rate 30-year amortizing mortgage. Rather, almost all homes were bought with below market interest only teaser rates. Those cheap rates meant that the house price didn’t matter anywhere near as much as the monthly payment. So with monthly payments now up big time, buyers are stepping back.

Second, the Bureau of Labor Statistics says 203,000 jobs were added in November. Sounds like a good number, right? However, how many of you know that the 203,000 November number is based upon all of 100,000 returned employer surveys? The footnotes to the monthly BLS report explains that there is 90% chance that November’s 203,000 new jobs number is within 100,000 of being accurate. In other words, there is a 9 in 10 shot that somewhere between 103,000 and 303,000 jobs were created in November. And if there is a 9 in 10 chance of being accurate, that means there is a 1 in 10 chance that there were less than 100,000 new November jobs. Remember there are 12 months each year and a 1 in 10 chance means that at least once each year, the BLS survey based payroll jobs guess is off by more than 100,000.

Third, just the other day the Bureau of Economic Analysis revised Gross Domestic Product growth to over 4%. What nonsense. Seventy percent of GDP is personal consumption expenditures. Where does the BEA get PCE from? The BEA bases 70 percent of GDP upon monthly surveys done by the Census Bureau of several thousand retailers. That is it. No real time data on spending from MasterCard or Visa, just a few thousand surveys.

The fourth reason providing inaccurate evidence of sustainable growth is the auto market where anyone breathing can now qualify for an almost zero interest rate auto loan. If much of future auto demand already been satisfied that means to me that auto sales will collapse if as and when it becomes more difficult and or more expensive to finance a new car.

The reality is the US economy is barely growing and there is no acceleration in sight. Wage and salary growth is quite weak right now. Remember, wages and salaries grew by 4 percent before inflation in 2012 and then after a 1% tax hike, wages and salaries grew by 3 percent for all of 2013. And, the current growth rate appears to be even slower.

I started this rant by saying I expect stock prices to keep going higher. And then at some point reality will step in and stocks will drop dramatically. I have been saying the same thing almost all of 2013. I have been right so far.

Below you may find the video.