Monetary Forces Appear To Be Gaining An Upper Hand

Many have been puzzled by the widening disconnect between what's happening in the financial markets and what's going on in the real economy.

For instance the 30% surge in the US major bellwether S&P 500 since March 9th has prompted for a record PE ratio.

According to Chartoftheday.com, This ``illustrates how this plunge in earnings has impacted the current valuation of the stock market as measured by the price to earnings ratio (PE ratio). Generally speaking, when the PE ratio is high, stocks are considered to be expensive. When the PE ratio is low, stocks are considered to be inexpensive. From 1936 into the late 1980s, the PE ratio tended to peak in the low 20s (red line) and trough somewhere around seven (green line). The price investors were willing to pay for a dollar of earnings increased during the dot-com boom (late 1990s) and the dot-com bust (early 2000s). As a result of the current plunge in earnings and the recent 2.5 month stock market rally, the PE ratio has spiked to the low 120s – a record high."

Yet for some analysts earnings will continue to plummet....

The above chart from Barry Ritholtz's Big Picture

For the bulls, this phenomenon translates to reflexivity- markets are sending signals of economic recovery.

But for the bears, this translates to a false dawn-an unsustainable bear market rally.

However we offer a third opinion: markets have been reflecting monetary forces gaining an upper hand. The sustainability of which will depend on the persistence of the application of inflationary mechanism by governments, especially the US.

Yet can stocks depart from fundamentals?

Let us look at history but from an extreme end.

The following charts are all from Nowandfuture.com

In 1920s the Weimar Republic in Germany experienced a hyperinflationary depression

As you can see above unemployment exploded!

Yet the stock market soared!However, the German currency the Mark fell of the cliff as the German government massively printed money!
Finally, hyperinflation-the cost of living skyrocketed!

So the answer is yes; stockmarkets or financial markets and the real economy can "disconnect" when monetary forces utterly overwhelms the economy. That's because when money losses its "store of value" functions due to excessive government policies to inflate, people look for a substitute. They accumulate or transact in foreign currencies, buy hard assets or conduct exchanges in barter. It's anything but the inflated local currency.

However, in the US, today's environment has been a raging battle between deflationary forces and government inflation, so the likelihood is sharp volatility until one of which will dominate.

Nonetheless since almost every governments had also been conducting their own variant of inflation, the surges in the commodity markets and world stock markets appear to be symptoms of monetary forces gaining an upper hand.

Hence we could be looking nascent inflation that risks developing into super-stagflation or at worst hyperinflation.