The paper vs. the real

The disdain for capitalism and the interest in socialism during the Great Depression scared the wealth/power elites into getting very proactive about implementing fiscal and monetary policies to ameliorate the worst effects of unemployment, poverty, etc. That was called the New Deal. The effort was successful. In its wake, after each recession since, they’ve moved more and more in the direction of managing the capitalist system and the financial markets. Confidence in their ability has resulted in euphoria in the markets.

The prices of paper assets (stocks and bonds) are supposed to be reflective of real-economy metrics such as productivity growth, profit levels, wage fluctuations, and savings levels. John Hussman says that corporate revenue (technically: “corporate gross value-added”) is the best single metric indicating the state of the real economy. Stock prices ought to correlate with corporate revenues, but, of course, the markets oscillate (sometimes crazily) as per investor sentiment. The markets go too high and then too low, but over time there figures to be mean reversion back to a “true value” correlated with corporate revenues.

The following graph shows the ups and downs of the sentiment-induced market lurches. Right now the latter are at an historical extreme.

To put it in lay terms:

It’s total insanity.