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How Long Can the Party in Stocks Last?


By the time the Fed becomes institutionally aware that inflation is raging across the globe, it will be too late.

Editor's Note: Chris Martenson is an economic researcher and futurist specializing in energy and resource depletion.

The headlines are screaming at the top of every financial media outlet tonight: The Dow Closes Above 12,000 for the First Time in Two Years!

What's going on here? Is the recovery well and truly underway? And, if it is, why is the Fed dropping hints again that "QE3 may get discussed" at future Fed meetings, as Kansas City Fed President Thomas Hoenig said on Feb 1?

Given the raft of good economic news lately, one might be forgiven for wondering what the Fed has in mind here. If everything is so economically rosy, why are they already dropping trial balloons about more quantitative easing? What are they seeing that we're not seeing, that justifies more than $100 billion in thin air money each month, and why won't they just tell us what it is?

Here's how a member put it earlier today:

I thought I heard CNBC state the other day that there was an inflow into the US Equities market which hasn't been seen in a while. I didn't catch the details, but I'm hoping that Chris has a read on this and an explanation on why the US stock market is so strong.

While it's true that retail investors have only very recently begun moving more money into stock funds than they have been removing, reversing a 33-month outflow, this is focusing on the wrong element in the equation. Retail investors provide only a minor amount of the rocket fuel used to elevate the stock market over the past several months.

Look at the amounts here, and also pay attention to the time frame:

Weekly Outflow and Inflow

Over a 36-week period spanning from May 2010 to the end of January 2011, there was only one instance of "investors" putting more money into stock mutual funds than they withdrew, and that one outlier was well under a billion dollars. Over that 36-week period, more than $100 billion was removed from the markets by investors. Even when money started moving back in over the past two weeks, I want you to note the scale; the combined total is $6.7 billion. Keep that figure in mind.

Instead, we should first focus on the massive injections of raw, potent, thin-air money (a.k.a. "credit easing") by the Fed into the financial system. Sometimes this is referred to as "liquidity," which it is. But that's too narrow a definition, because it is much more; it also happens to be high-powered base money (a.k.a. "Wall Street rocket fuel").

Here's the stock market story over the past eight months:

Quantitative Easing Chart

Note that QE2 began in early November of 2010 and that the stock market is up 20% since the end of August.

As an aside, I used to track the Fed's thin-air money programs very closely, and if you had told me as recently as three years ago that the Fed would have been running 11-figure POMO operations each and every month, I would have told you it was unthinkably impossible. But here we are, that is exactly what is happening, and I am largely numb to the process, which worries me somewhat, as it means that my baseline has shifted.

At any rate, the point here is that from those August lows to now, retail investors have taken out far more money from the stock market than they've placed back in; a total of around minus $38 billion.

But over that same period, the Fed has placed nearly an entire order-of-magnitude more thin-air money, some $350 billion dollars, into the hands of financial institutions, some of whom consider the stock market their personal playground.

Here's a chart of the cumulative POMOs by the Fed from the end of August 2010 to now:

Fed Money Printing, POMO

Should we consider the injection of more than one-third of a trillion dollars and a stock market that is up by 20% to be a coincidence? No, not in the least. The stock market has become, if anything, a liquidity gauge first and a discounting machine second. The fundamental that matters most is how much money is flowing into the machine.
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No positions in stocks mentioned.

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