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The New "Normal"

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I was having a chuckle this morning when Zacks in-house permabear changed his coat.  

Here is what Sheraz Mian said in his daily commentary this morning:

"This earnings performance is not consistent with a stock market in record territory. But it’s not earnings and economic fundamentals driving this rally – it’s cheap money. As long as that policy remains in place, investors can afford to overlook issues like earnings and economic data."

Now, having had some fun at his expense, I decided to write a short piece on this topic.  Because it is very important to investors in today’s market.

What drive stock price indexes in normal times are earnings and economic fundamentals. However, the problem with that statement is all in the use of the word “normal.” There is something massive and hidden behind that word: it is our government. What happens to economic and financial data is that they are produced under a government regime.

Call it a “state of nature.” Without any stable framework of rules emanating from a government, we wouldn’t even have a functioning stock market. It would not be possible to trade with any confidence.

It’s just “Animal Farm” all the time.

Think of today’s stock market without 10-Ks and 10-Qs and the quarterly conference calls that come with them. All of this? Enforced by the SEC, inside the Federal government. These quarterly reports didn’t actually exist in their current form until after the Securities and Exchange Act of 1934 in the U.S. That global financial crisis reshaped our financial landscape irrevocably.

In other words, a state of nature is firmly submerged behind any economic or financial relationship. Replacing and rethinking the word “normal” is the subtlety that opens the door to why this stock market is going up.

The stock market is going up because there has been a fundamental regime change, sweeping all central bank policies of the past out of the way. They will not return again. The “state of nature” -- what is “normal” -- is now irrevocably over for good. Just like in 1934.

Think of “normal” in terms of a bathtub. If earnings growth and revenue growth is weak, the water flowing into this stock market bathtub will be drained out of the tub fast, and the level of water will start going down. Stock prices will fall, in other words. That is “normal.” It would also be extremely alarming to any central government.  

Draining water doesn’t happen when you plug the drain. The government’s money printing exercises are doing just that. While the entry of water is weak (earnings and revenue growth currently play that role), plugging the drain with free money makes the weak flow strong enough for the bathtub to overflow, no matter what.

Stock prices rise.

That does not mean all is well, either, or that these weak earnings and economic fundamentals should be ignored. What it means is investing in these markets is not done well just on established relationships built on top of government regimes from the past.

Whenever I look at a scatter plot, or any other two dimensional economic or financial relationship -- in any top-down strategist report -- I am reminded that all I see is actually manufactured by the state of nature, or government regime I am living in.  Or better put, the government regime I was living in.

The massive 2008 financial crisis was strong enough to force change on our “state of nature,” on our framework of government.

A new “normal” has emerged. That makes all the difference.

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