Why is the Stock Market Going Up?

Dow Jones Industrial Average

The Dow Jones Industrial Average has just passed the 14,000 mark, yet the U.S. unemployment rate has just today ticked up by 1/10th of 1% and the U.S. economy (as measured by our GNP) shrunk in the fourth quarter of last year by 1/10th of 1%.  What's going on ... isn't this an economic disconnect?  No, I think that the U.S. stock market is presaging the entrance of that red-eyed monster ... increased inflation.  We all know that the Federal Reserve's actions over the last four years ... producing new money until the Mint's printing pressing are overheating (producing over $3 trillion in new money) ... has to bring back inflation.  The nervous question has been, "When?"

Well, all this money sloshing around our economy has to go somewhere.  And it is starting to find its way into hard assets ... into the formally-wretched housing mark, into commodities, and into the stock market.  And it is fleeing the fixed-income market ... corporate debt, municipal bonds, and various U.S. government obligations.  (The yield on ten-year U.S. Treasuries has, over the last few months, increased from 1.42% to now 1.90% and heading north ... reflecting the equivalent decrease in the price for these bonds).

One caveat for investors ... the stock market will go up in an inflationary environment until such time as run-away inflation starts to damage corporate profits ... or looks like it might.  My guess would be that this effect would kick in somewhere around an inflation rate of 6-8% ... so be careful.

Afterward: For some parallel thoughts on this subject see: Powerline Blog