The Markets Are in Trouble

Let's be honest, the last couple of years in the stock market have been wild. We've seen a 60% jump in US stocks. Think about that – that kind of return used to take decades. My Wall Street days taught me that markets move in cycles, but this feels different. It's like we're in uncharted territory.

A Market Surge Amidst Main Street Struggles

Here's the kicker: while the market's partying like it's 1999, a huge chunk of Americans are just trying to make ends meet. We're talking record numbers living paycheck to paycheck. Consumer sentiment is still down in the dumps, levels we haven't seen since the thick of the financial crisis. It's a bizarre disconnect, right?

This isn't your typical economic recovery. It's more like a wealth gap explosion. Money is flowing from the everyday economy straight into financial assets at a pace we've never witnessed before. It’s like two separate worlds operating at the same time.

Is This Bull Run Running on Empty?

So, the big question everyone's asking – can this stock market party keep going? History gives us some clues. Massive 60% rallies in two years are rare. When we've seen them before, like in 2021, 2011, 1996, and 1987, big market corrections often followed, sometimes around 20% drops. Ouch.

Now, a 20% drop today would sting, taking us back to late 2021 levels. But these kinds of corrections aren't random. They need a trigger, a specific set of circumstances. Otherwise, the market can just keep climbing, like it did in the late 90s boom.

The Inflation Factor: The Key to the Puzzle

What’s the secret ingredient that separates market corrections from continued rallies? It boils down to one word: inflation. Look back at those correction years – 2021, 2011, 1987. What do they have in common? Inflation spiked. It jumped from low levels to 4% or higher, and boom, markets reacted.

Contrast that with 1996. Inflation wasn't spiking; it was actually trending down. And what happened? The market kept soaring until the dot-com bubble finally burst. Higher inflation usually means higher interest rates, which can lead to economic trouble. Low inflation? Often the opposite.

For the last couple of years, despite all the noise, inflation has been trending downwards. That's a major reason why we've seen this market melt-up. Many have predicted inflation would roar back, but the data, especially when you dig into things like rent prices, suggests it's still easing.

Rent data, particularly new tenant rents, is a pretty reliable predictor of overall CPI rent inflation, and it's been showing contraction for the first time since the financial crisis. That's a big deal because rent is a huge chunk of the inflation picture.

Low Inflation, Diseased Economy?

Now, don't get me wrong. Low inflation isn't necessarily a sign of a booming, healthy economy. In fact, I think it's more of a symptom of a different kind of problem: wealth inequality.

Think about it. The average US consumer is feeling the pinch. Low confidence, low savings, and high debt. People just can't afford to pay higher prices without some kind of massive government stimulus, like we saw during the pandemic.

But here's the other side of the coin: corporate profits are through the roof. They're at levels we haven't seen in history, representing a massive chunk of the entire US economy. And where does all that profit go?

A lot of it gets reinvested right back into financial assets, pushing stock prices even higher. It's a self-reinforcing cycle.

Navigating This Two-Speed Economy

So, what's the takeaway? As long as inflation stays low, the party in financial assets could keep going, at least for a while. That's been the story of 2024, and it could continue into the first half of 2025. Markets can be irrational for longer than you can remain solvent, as they say.

Now, things can change quickly. We always need to be ready to adjust. And while we might take some short-term defensive positions here and there when risks pop up, the bigger picture is that this market has momentum as long as inflation remains subdued. Keep an eye on the data, stay informed, and don't get caught up in the hype or the fear. It's about understanding the underlying forces at play.

This market is a puzzle, no doubt. But by focusing on the key pieces, like inflation and the real economic drivers, we can make sense of it and navigate it effectively.

Stay sharp out there.