The financial markets are guided by supply and demand conditions for stocks and bonds. Historically, their fluctuations have been heavily influenced by business conditions and economic cycles. During the past 12-15 months something new and different has dominated the marketplace. Unorthodox governmental forces are the engine that drives the financial markets which seem totally insensitive to any negative economic developments.
Most people believe that when the stock market is going up, the economy must be doing well. The argument was generally true in the 20th century. Now a days, things are different in the era of the New Normal. So far in the 21st century, when both the bond and stock markets are cheering, the economy may actually be slowing or operating below trend.
Irving Fisher, who was one of the well-known economists of the early 1900’s, came up with the “Equation of Exchange” concept. In its time, it became a landmark theory and today, many people still consider the equation to be one of the most important theories of economics.That equation was MV=PT to explain the key relationships as to how these variables interact with each other and the economy. M is the money supply. V is the velocity of money. Essentially this says how quickly the money supply is turned over. P is the price level. T is the aggregate transactions. So MV = PT means that the total transactions at the current price level is equal to the total money stock multiplied by how often it is turned over.
In sports, business or most avenues of life, people are encouraged to learn, imitate or follow the winners. In golf, we want to learn from Rory Mcllroy, Adam Scott or Phil Mickelson. In tennis, we want to emulate Novak Djokovic, Roger Federer or Rafael Nadal. To this motivational wisdom of following the winners, there is one exception, however. Central bankers seem to like to follow the loser.
Quantitative Easing ("QE"), creating money to buy bonds issued by the government, was first used by the Bank of Japan in the early part of the 2000’s. Japan was once known as the land of technological and engineering marvels, but more recently it has become known as one of the worst-managed economies in the world. The lost decades of the 1990’s/2000’s have extended into the 21st century, with subpar economic growth, Fukushima radiation out of control and a declining population amongst the list of negative trends.
Both commodities and stock markets are considered leading indicators in economic analysis and forecasting. In 2014, the prices of industrial commodities including copper, oil, gas, steel and coal declined sharply. On a currency adjusted basis, the stock markets of Germany, Japan, Brazil, Australia, United Kingdom, Russia and Austria also fell. In the United States, the Dow Jones Industrial Average started the year at 16,576, down 2.8% to 15,935 as of October 16th while the Russell 2000 small cap declined 6.6% and S&P was flat in the same time period. The markets were signaling a possible economic slowdown in the G7 countries.
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