Right now we sit in an unusual place in financial history: World fundamentals are taking a back seat to policy makers who are defending the current system with new monetary tools. As market analysts, we’ve watched the perpetual bull and bear debate grow as divisive as ever, and while both camps have impressive arguments, neither camp has enough history to make their case.
Many bears are currently objecting to the Federal Reserve’s thesis that inflating financial assets should produce a wealth effect that increases confidence and helps jump start spending. John Hussman is one such skeptic, and in his weekly market commentary he argues that the multiplier effect from rising stock prices should produce no more than a 0.05% increase in GDP. If he’s correct, we’ll all agree that we can’t rely much on the wealth effect of rising stock prices to get our economy humming again.
Of course the bears typically leave out the more positive multiplier effect that may be slowly building despite the daily dose of gloom about Europe, China, and the fiscal cliff. The positive story comes from the housing market, where studies on the housing multiplier are much stronger than those coming from stock prices. Some research has shown that each dollar spent on residential construction can generate as much as $1.27 cents in additional economic activity.
So which multiplier effect will win out? In all honesty, we can’t be sure. At Pinnacle we are tilting our portfolios in the direction of the housing bulls… but with plenty of diversification and some hedges in case we end up being too optimistic.