The Flinchum File
Thoughtful Economic Analysis and Existential Opinions

Increased Cash = Increased Demand

01/09/2021

The most common question I receive is how can the stock market do so well, when the economy does so poorly? The short answer is that the economy reflects the present, while the stock market reflects the future. A better answer is that the price of stocks reflects the supply and demand for stocks. The supply of stock is not fixed, but it increases slowly.  The amount of cash available for the purchase of those stocks has increased rapidly, bidding up the price of those stocks.

First, huge deficit spending by the Federal government injected cash and steadied the overall economy initially. The Federal Reserve’s asset purchase program steadied the financial markets and was virtually a promise by the Fed that they would not let the stock market crash.

Second, while Americans idled at home during the pandemic lockdown, they were spending less money and their savings increased, on which the banks paid them virtually nothing in interest. Often, the dividends paid by stocks was much greater than the interest paid by banks. A favorite expression on Wall Street is TINA – there is no alternative to stocks. Additional froth probably resulted from stimulus payments to employed people, who used their payments to buy more “cult” stocks, such as millennials buying Tesla and bitcoin.

Another major source of demand for stocks was margin buying, whereby you can borrow against your existing stock portfolio to buy even more stocks. Margin borrowing reached an all-time record high of $722 billion in November. That’s a lot of additional purchasing power for stocks.  However, I would fire any client who did this.

You knew the  demand for stocks was huge, when the market shrugged off the Capitol insurrection, and reached a new high anyway.

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