Evidence of Bubble in Stock Prices when Compared with Industrial Production

May 19th, 2013
in contributors

by Lee Adler, Wall Street Examiner

Industrial Production fell by 0.5 percent in April on a seasonally adjusted basis after having increased 0.3 percent in March and 0.9 percent in February, according to the Fed. The consensus estimate was for a decrease of 0.2%. Economists had been missing to the optimistic side on most forecasts for the past several months. This month they course corrected and now their estimates are too low.

The media only pays attention to this silliness because it has nothing better to do. I’m more interested in how the the trend of actual, not seasonally manipulated, economic data lines up with the performance of the stock market, since there is some historical correlation.

Follow up:

The actual, not seasonally adjusted number, fell by 1.3 points month to month and was up 2.4 points year to year. That was slightly weaker than the March year to year gain of 2.9. Month to month changes in April have always been a decline over the past 10 years. In 2012 April was down 0.8 and in 2011 it was down 2.1. The average April change over the past 10 years was a decline of 1.8. This year’s performance was better than average.

The “good news” must be kept in perspective however. Industrial production levels remain below 2007 and even early 2008 levels. US population has grown by 5% since then, the Fed has pumped trillions into the financial system, and US industry is producing less now than it did 6 years ago.

Click to enlarge

Stock prices have broken out as industrial production has lagged. That suggests that stocks are in a bubble. As the Fed continues QE, I would expect both to move more or less together. If the lag in industrial production grows the bubble would increasing in size and growing more dangerous.

By shrinking the SOMA (System Open Market Account) in 2007 and 2008, the Fed starved the Primary Dealers of the cash they needed to keep the game going, and both the stock market and economy crashed. The situation is exactly the opposite this year as the Fed adds a net of $85 billion a month to SOMA through gross purchases from Primary Dealers of  around $110 billion per month currently. There’s no reason today to expect the rally to end. That will change at some point, but all the speculation about the Fed’s next move notwithstanding, we’re not there yet.

In 2007 when this indicator was peaking along with the stock market, the Fed had already pulled the plug on growing the SOMA. That’s what ended the bull market, not the fact that stocks were extended. I would expect something similar to end this bull move. I doubt that simply slowing the pace of QE would do it. But at some point the dangers of the bubble will become so great and so obvious that the Fed might pull the plug completely. That would probably precipitate the kind of crash that ends all bubbles.

This report is excerpted from the permanent charts page on Industrial Production and Electric Power Generation.

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