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Economic Review

8/24/2009

Equity exuberance quickly regained momentum, but sound fundamental support still remains at bay

Despite a bout of weak economic data about a week ago, US equities quickly shrugged off short term selling to resume an exuberant trend higher.  Friday’s action was buoyed by a small surprise in housing data, but barring that indicator, fundamentals remain rather suspect.  So what’s driving stocks higher you ask?

One underpinning for higher US stocks that reared its ugly head again last week was talk of the reflation or should we say inflation trade in the US.  In other words, the powers to be may sacrifice a stable currency platform in order to increase valuations of asset prices as an impetus to jump start economic activity.  Allowing the US$ to continue to depreciate would make US goods more attractive abroad, and also increase profits for some multinationals who receive payments in foreign currency.    Higher prices at home could also be a driver to placing a bottom in the decimated US real estate market.

Another result of this could very well be rising prices in stocks as well.  However, the inflation trade is simply not a sound fundamental underpinning to any economic system and a sustained weak currency could be quite dangerous over the long run.

The bottom line…can stocks go higher?  If the inflation trade continues, all bets are off from the Doc on Equity market direction.  Yes, stocks could continue to move higher, but the underlying risk to holding these assets will be substantial.

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