Open Thread: Stock Market Edition

Two weeks ago, the Dow hit a major low at 6440, closing slightly higher. This made a lot of sense to me, given the fundamentals of the economy. In fact, I nearly posted a rather snide article on CNBC “calling the bottom” that morning.

But then things changed. The Dow has been on a tear ever since, culminating yesterday in a 500-point rise. This is a 20% rise since its lows of merely two weeks ago. And I just don’t understand why.

I see three potential explanations:

  • We’ve hit the bottom of the recession, and the 6440 low was an undershoot on the downswing, which was bound to be quickly reversed.
  • This is a sucker’s rally, and the Dow will soon drop again.
  • We haven’t hit the end of the recession, but the inflationary policies of our government are going to cause a rise in equity and asset prices.

I don’t believe the first. I can be wrong on that, but I think there are structural monetary and economic issues that are still bound to unwind. The government is trying to reinflate the bubble, but I think there’s too much leverage working against them.

I can easily believe the second. I think there’s quite a lot of downside risk, and after such a phenomenal drop, I actually believe there’s plenty of suckers who thought we’d hit bottom.

What really worries me is the third option. If the inflation is starting, this has significant impact on my personal situation. As a renter, I want to purchase real estate before the inflation really hits, locking in a nice low fixed interest rate on a home that’s going to rise in value with the devaluation of the dollar. If the interest rates spike before I can buy, I may be locked out of ownership in any of the neighborhoods I’d actually want to live in.

So what does everyone think? Where will we be in a month, in 6 months, and in 18 months? Is this a sucker’s rally, is this the start of the great inflation, or is this simply the bottom of the recession and things are looking up?

  • Peter

    The federal bailouts have been anounced with no offsetting cuts in spending, so inflation will inevitably happen. It probably has already started, but it will take a while for the statistics to show the trend. I believe inflation will be too slow to cause such a dramatic increase in stock prices without an accompanying price increase in everything else, at least at first.

    I think that this rise in stock prices is a combination of three factors you suggest, inflation is starting to kick in, we are hitting the bottom of a recession (or at least a plateau, once the government gets this “stimulus” going we may be in for another drop) and perhaps prices were actually too low and now rebounded too high.

    I am not an economist or a prophet, but my prediction is that the stock prices will drop back to where they were a few weeks ago, and jump up and down by large amounts. I think that the inflation will set in soon, and the prices of houses has reached a minimum. Obama and his friends are doing everything they can to raise the prices of houses, so now is a good time to buy a house or two. (There are exceptions, depending on local conditions, like Detroit: I think that with the poor performance of the auto companies Detroit housing market will continue to drop.)

  • Chad Butler

    I think that there is a strong possibility that a bottom is in place. However, there is always a chance of additional downside. Also, that does not mean that we will embark on a new bull market. In fact, I think that a return to the record highs of 2007 are unlikely at present, and also in the next 18 months.

    Your insight on inflation risk is key. A big piece of this current move is the “pricing in” of inflation. A portion of the current move in the Dow (and other indicies) is the result of inflation. The text of last week’s FOMC announcement was taken to be inflationary and the dollar took a steep dive along with a huge rally in commodities. At least part of the gains in the stock market is due to this inflation move, which means that they were not, in fact, real gains, but an adjustment to a weaker dollar.

  • Quincy

    I don’t think we’re seeing the beginning of massive inflation *yet*. So long as the credit market remains moribund, the massive amounts of currency dumped into the market by the Fed are actually offsetting the previous over-leveraging of the financial industry, allowing price levels to remain relatively steady.

    The problem is that all those new dollars out there are actually an inflationary time-bomb waiting to blow up in our faces. Once the financial industry starts trying re-leverage on the much larger base of dollars, expect inflation to hit like a hurricane. My prediction is you’ve probably got 12-18 months calm before the storm here.

  • Miko

    The price of gold suggests that inflation is a ways off (although it’s less of an indicator now than in the past, since the price of gold is also tied strongly to the price of the euro now; expect gold to skyrocket when the euro starts inflating too). I’d suggest it’s because the government has announced it’s going to be buying toxic bank assets. To have any impact different from what the free market would, the government is going to necessarily pay more than these assets are worth, so they’re essentially telling investors “buy now and we’ll subsidize the bad parts for you.” It’s even possible that they’ll stay at the higher level (since although government has done nothing to actually solve the underlying problem, it’s agreed to transfer the problems onto different balance sheets), although what’s more likely is that the insiders who stand to profit from this will sell at the peak and the stocks will return to previous levels.

    My prediction is that we won’t see massive inflation for at least six months: although the government is attempting to massively inflate the currency through the printing of new money, their attempts are being frustrated by a slowing of the velocity of money (i.e., banks are lending less). There’s a causal relationship between these two factors, but barring the velocity slowing to zero (i.e., total financial meltdown end of the dollar scenario), the increased money supply is going to eventually overwhelm the slowing velocity and money is going to flow out like water over a broken dam. The timeline is a rough guess, but could even be too long, especially if the Fed lowers rates.

  • Justin

    This is a sucker’s rally which may last long enough for people to think “it’s over.” This capitulation point will coincide relatively well with all the CNBC pundits saying things are okay/giving the “all clear” to get back in the market.

    Right about that time the market will resume its downward course which will ultimately result in new lows.

    Meanwhile, gold will plug along at about the same level it is now, maybe even rising a bit though I’d expect to see volatility/price fluctuation even as it more or less stays at the same level. As the market resumes its downward trajectory, the dollar gets further devalued, and the treasury continues creating more and more debt, gold will increasingly be seen as a good investment. Treasury yields will start to rise, and there will be a flight to real assets.

    It probably won’t happen so neatly, but that’s how I expect this all to unfold. The key thing to watch is the treasuries — this is the last bubble that the Fed is trying to keep inflated, which is why they have promised to buy so much MBS and treasuries in 2009. The problem is that they are increasingly pushing on a string.

  • Merf

    This is a sucker’s rally. More foreclosures are on the way, even in areas that saw only a reasonable amount of growth instead of Florida’s and California’s hyper-growth. Here in the Portland, Oregon, area, things went up, but not the insane way they did other places, and we are dropping, still, and I expect it continue until we hit 1999-2000 prices.

    As for gold, it might work as a barometer, but it has no other effect or worth, unless you intend to make it into jewelry.