Fantasy Land

Monday, stocks in Asia lost 1.2% but in Europe they closed flat. In the U.S. stocks gained 0.3% on low volume. VXO plunged 13% to settle at 12.74. Tuesday, Asian stocks reversed to recover most of the previous day’s losses, closing up 0.8%. Stocks in Europe skyrocketed 1.8%. In the U.S., stocks rose 0.9% to propel the Dow Jones Industrial Average to a record high. The VXO continued downward, this time 4.5% to end at 12.16 on light volume.

Before you go on your next buying binge, you might want to take a look at a return to reality that compares the last time that the Dow made a record high to now. My theory here is that this greater fool pop is a relief rally celebrating that a catastrophe did not happen when the sequester kicked in last Friday. Making the case for more of the same, here’s an interesting article that maps stock prices to the Fed balance sheet. Do I think this will happen? It’s simply not reasonable. In a secular bear market, you simply do not make massive bull runs. Something’s got to give.

In searching for information to explain the unreasonable stock market rise in response to QE-Infinity I found this good article on shadow banking. According to Wikipedia the stock market is very big—especially if you count derivatives:

The size of the world stock market was estimated at about $36.6 trillion at the beginning of October 2008. The total world derivatives market has been estimated at about $791 trillion face or nominal value…

Also according to Wikipedia, the worldwide bond market is pretty big also.

As of 2009, the size of the worldwide bond market (total debt outstanding) is an estimated $82.2 trillion, of which the size of the outstanding U.S. bond market debt was $31.2 trillion according to Bank for International Settlements (BIS),…

Finally Wikipedia reports the shadow banking assets in a comparable area to the stock and bond markets.

In November 2012 Bloomberg reported on a Financial Stability Board report showing an increase of the SBS to about $67 trillion

The question becomes, if $85 billion monthly excess demand is split among stock and bond markets, how much of an impact will it likely have? Assuming that all of it makes it to bid up the stock market somehow and assuming a normal linear demand curve for stocks, we’re talking about a dilution of about 0.2% per month or about 3% per year. That should be the upper limit of the bias. You may say but what about leverage? Okay, if you talk leverage of 10 to 1 and you apply it to just the derivatives market you get a number half that large. Either way, we should not see anywhere near the kind of gains we’ve seen in the last four years (24% per year), let alone the torrid 55% annual pace seen in the last four months.

The rally in the West continued into Asia Wednesday with a 1.1% gain. The party stalled out in Europe as stocks there declined 0.3%. In the U.S., after trading in positive territory most of the day, stocks closed nearly even on low volume. While gold and silver had modest gains for the day, miners roared upward 4%. Thursday Asia up 0.6%, Europe down slightly, U.S. up slightly on low volume. VXO fell 3% to close at the unsustainable 11.99 level. Elsewhere in fantasy land, Facebook gained over 4% on a really novel idea of presenting customized news on-line while IBM is now knocking at the door of $210.

Stocks in Asia again moved upward Friday, rising 0.5%. In Europe the rise was 0.6% and in the U.S. 0.5% on low volume. Here’s an article that indicates that the Fed may not sell it’s bonds but just let them expire. The employment numbers came in surprisingly positive with the unemployment rate dropping to 7.7%. As usual, a look beyond the headline gives a less rosy picture. Apparently, it doesn’t matter whether the news is good, bad, or indifferent. All news is positive for the stock market unless the Fed says so.

For the Week
After dipping down to 1.85%, the 10-Year U.S. Treasury Bond rate soared nearly 11% for the week to close at 2.05%. Stocks roared upward over 2% while the VXO collapsed nearly 25% to close at 11.63. IBM powered upward nearly 4% to close above $210.

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