I am the first to admit there are a whole host of economic realities that baffle my one-watt brain.  As a scalper, I don’t worry about, at least in a trading sense, how the overall market is performing or what direction the market is trending.  I trade what I see on the chart, for the most part.

But that doesn’t mean I don’t think about things from time to time…and the recent rally in the stock market has me scratching my head some.  I think Benjamin Graham would be shaking his head some, too.  This chart is mind boggling:

spx daily chart

The market has shot up to extraordinary levels in recent months on news that…ah…ermm…earnings are down.  Huh?  It’s true, the economy as whole has stopped the free fall we experienced early in the current year, and we have had a steady stream of “it’s not as bad as it could have been” kind of economic reports.  But this news is hardly the stuff of “green shoots” some economists have portrayed.  To be sure, revenues are down in double digits percentage points from last year, and purchasing power, as measured by tax receipts, is off 22%.  Things aren’t nearly as rosy as many would have you believe.

To go a step further, where in the heck did all this money to fuel this rally come from?  Only 400 million dollars has flowed out of money market accounts and into the market.  So that kind of kills the “money was on the sidelines” theory.  It takes a major commitment of cash to run the market up to the levels we are now seeing.  Somebody is buying stocks in a big way.  But who?

Zerohedge nailed it, I believe:

Why the Federal Reserve of course, which directly and indirectly subsidized U.S. banks (and foreign ones through liquidity swaps) for roughly that amount. Apparently these banks promptly went on a buying spree to raise the all important equity market, so that the U.S. consumer who net equity was almost negative on March 31, could have some semblance of confidence back and would go ahead and max out his credit card. Alas, as one can see in the money multiplier and velocity of money metrics, U.S. consumers couldn’t care less about leveraging themselves any more.

So I find myself thinking that essentially the Fed has subsidized banks who, in turn, subsidized the stock market with what is essentially “zero risk” money because, after all, these banks are “too big to let fail.”  Of course, the economic reality of this Dr. Strangelove-like dichotomy lies in the near future.  I would think, no, I know that the real investment is essential in the market, from real people, for any rally to sustain itself.

Did I mention someone, namely the banks, are making some obscene money, or what I term “stupid money” in this process.  Stupid money always begets a return to reality, and the reality of our current situation isn’t pretty.

Earnings are down, and fundamental theory is quite clear on this point.  Revenues and earnings increases are essential for a healthy market.  We have neither.  Broad participation from the entire investment community is essential…and I believe, with good reason, that the average investor has become risk averse as a result of the butt-toasting he/she has received in the last year, especially in their 401k accounts, that the farthest thing from the less-than-astute stock investor’s mind is to jump headlong into the market with the tattered remains of their retirement assets.  I just don’t see it.

The reality of the situation seems to be the rally has been financed and fueled by the quantitative easing policy and TARP funds the Fed has made available to distressed banks.  Having worked hand-in-hand with the investment banking hierarchy during my trading years, there is no length they will not go to so they might “game the system.”  But really, does the US taxpayer, via the Fed, need to be involved in creating stock market bubbles?

Because that is what I believe, we are experiencing another bubble in equities created by loose economic policy.  Unless earning and revenues show dramatic turnaround, how in the world can the current prices be maintained?  There must be some fundamental reason for equities to become more valuable..ie- their prices increase.  I just don’t see the justification for the whole mess.

And I think, in the final analysis, you will see another mess.

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