Four “Proofs” Stock Market Rally Will Fall Flat on Its Face

By Michael Lombardi | Small Business

Four “Proofs” Stock Market Rally Will Fall Flat on Its Face image 251013 PC lombardiFour “Proofs” Stock Market Rally Will Fall Flat on Its FaceHistorically, key stock indices and the price of copper have moved in line with each other. Why? The relationship is very simple: copper is an industrial metal, and when demand for it is increasing (and its price rises), it means companies in the economy are producing and selling more. Investors usually take that as a bullish signal for key stock indices.

But today, we see copper prices and key stock indices moving in the opposite direction of each other.

Below, I’ve put together a chart that shows the action of both the S&P 500 (top of chart) and copper prices (bottom of chart). The chart shows that since 2011, the S&P 500 and copper prices have been moving farther apart.

Four “Proofs” Stock Market Rally Will Fall Flat on Its Face image SP 500 Large Cap Index Chart4Four “Proofs” Stock Market Rally Will Fall Flat on Its Face Chart courtesy of

But the chart of the S&P 500 above doesn’t just show its relationship with copper; it also shows that volume on the S&P 500 has been declining. Look at the bars just below the rising trend of the S&P 500, and you will see I have drawn a line showing a significant decline in volume on the S&P 500—fewer and fewer shares are being traded despite the index trading near an all-time high.

Historically, and like any asset, prices rise when demand rises. But today, we have the S&P 500 moving higher on declining volume—a historical omen for the markets!

And corporate revenue growth (the mainstream focuses on corporate “earnings”) are worrisome, too.

We are in the midst of the third-quarter earnings season. As of October 18, of the 97 companies in the S&P 500 that have reported, 69% of the companies have reported earnings above market expectations. But only 53% of them were able to beat revenue expectations! (Source: FactSet, October 18, 2013.)

Companies showing better-than-expected corporate earnings but missing out on their revenue targets is a signal to me that companies are achieving profits through financial engineering (stock buyback programs and cost-cutting) as opposed to real growth. How long can these “tricks” go on for?

Putting aside what I just said, we know key stock indices are a forward-looking animal. So maybe, by rising so high, the S&P 500 and other key stock indices are telling us the economy is improving? Wrong, again.

The U.S. economy is in a deep hole, and it’s going to take a very long time for it to get out. As I have been writing, the most powerful factor that drives the U.S. economy—consumer spending—is in serious trouble.

Wherever I look, the fundamentals behind any rally in key stock indices are missing. The prices for key commodities like copper and oil are falling, stock market trading volume is declining, corporate revenues are showing almost no growth, and consumer spending and sentiment are very, very weak.

So why are key stock indices rising? It all has to do with money printing.

Here’s what has happened: The Federal Reserve, through its quantitative easing, has been effectively creating $85.0 billion a month in new money out of thin air and using the new money to buy bonds from the government and mortgage-backed securities (MBS) from banks.

Look at the table below. It shows the percentage increase in the Federal Reserve’s balance sheet (in other words, money printed) over the past month or so.

Date Assets on Federal Reserve’s Balance sheet % Change from Previous Period 9/4/2013 3,654 Billion 9/11/2013 3,662 Billion 0.21% 9/18/2013 3,722 Billion 1.64% 9/25/2013 3,734 Billion 0.32% 10/2/2013 3,747 Billion 0.36% 10/9/2013 3,758 Billion 0.30% 10/16/2013 3,813 Billion 1.46% Total Change 4.30%

Oh my, what a coincidence! In the same period the Federal Reserve’s balance sheet has gone up by 4.29%, the S&P 500 has increased by 4.92%.

Dear reader, the fundamentals that drive the key stock indices are simply not there. Key stock indices are rising because, somehow, the Fed’s newly printed money is making its way into the stock market.

Marty Zweig, a famous stock market analyst, coined the adage, “Don’t fight the Fed.” Marty was right. But Marty never dealt with a situation in which the Fed was creating so many trillions in newly printed money. If I had to crudely rework the adage today, I’d simply say, “Printing money to boost stock prices is a scam, and like any scam, it will eventually fall flat on its face.”

More Business articles from Business 2 Community:

Subscribe to our mailing list
* indicates required
Small Business Services