Therein lies your answer: What has driven this bull market higher for the last 8 years was not "economic fundamentals," but
liquidity
— in this case, provided by the world’s Central Banks (CBs).
Essentially, the world’s various CB’s have been running the printing presses almost nonstop since 2009. Much of that excess cash has found its way into the
stock market, which has driven prices higher. Some might say
“artificially” higher, since the fundamentals of the real economy do not
support current pricing (especially in terms of production).
So, the CB’s have been responsible for inflating asset prices by flooding an exorbitant amount of liquidity into the world. One problem with their "free money" approach is that it sends
false signals to the market that there is more demand for things than the actual, real market would support.
Let me draw an analogy as to why this is a problem using the following story, titled:
The Acrobats
Imagine you owned a hotel in a small town for the last 10 years. After 10 years, you have a pretty good feel for what the market supports for your business. You have the right number of employees, the correct hours set for them, your income and expenses are well-balanced, etc..
Then one day a large, traveling band of acrobats shows up, and they rent out an entire wing of your hotel. Well, that’s good news, right? You’re pulling in more income than ever!
These acrobats initially book their rooms for a week, so you don’t make any changes whatsoever to your business model. You understand this situation is temporary.
A week goes by, and the acrobats announce that they’ll be staying for another week. Great! Still nothing Earth-shattering — you might have to get a few employees to work longer hours, but again, your business model doesn’t change.
The next week passes, and the acrobats announce to you that they’ve decided to set up shop in your town, so they're going to "
move in" for an undetermined amount of time. They are a superstitious lot, and they don't believe in owning land, so they tell you they'll be staying at your hotel for
“at least 10 years.” Holy cow! Amazing news!
But... Your hotel is no longer going to be large enough to support its usual customer base, because these acrobats will be “permanently” occupying one whole wing.
This changes your business model.
You decide you need to expand, because after all, the local artist festival this spring is always a full house -- but with the acrobats occupying so much space, you won’t have room for the artists anymore. Same with the Harvest Festival this fall. And over Christmas, there are always a ton of relatives in town, causing the hotel to fill up…
So you decide to build a new wing, similar in size to the wing that is now “permanently occupied” by the acrobats. You also figure it's a good time to remodel, and you decide on a "more upscale" look for the hotel. You can charge higher rates now, because with the acrobats providing a steady source of income, who cares if a small handful of your old customers can no longer afford the stay?
Plus, wow! Interest rates are incredibly low right now, so you might as well finance everything at once. The acrobats will more than cover the payments on a 10-year loan anyway. When they move out, you'll be paid off!
You also hire more employees and expand the hotel’s restaurant.
Business is better than ever, and things are going great!
After a while, your business has not only adapted to "the new normal," but your business model is now, in fact,
predicated on it. After a while, "the new normal" is just
normal. And you forget what life before the acrobats was like.
But then... sudden tragedy strikes. Only three years after the acrobats told you they’d stay for “at least 10 years,” their star performer suffers a nasty fall and is permanently injured. He and his family leave the hotel. So do his two performance partners.
The rest of the troupe then decides this location is "bad luck." They tell you that despite their long-term promise, they’re not going to stay any longer than they already have. They pack up and leave town.
Your hotel is suddenly very empty. And not only very empty, but very
large and empty. You have to lay off half of your workforce immediately, including three-quarters of the Housekeeping staff.
The huge, recently-expanded restaurant starts running specials to attract more customers. At first, it's "Kids eat free on Tuesday and Thursday!"
When that fails to bring in enough business, you try: "Kids eat free on
any weeknight!
Then: "Kids eat free
every night!"
But to no avail.
And the loan payments! Sheesh, those seemed like a walk in the park when the acrobats were in town. Now you can barely keep up. You slowly begin to realize that
you may have to sell the entire hotel... But who's going to buy a huge, fancy hotel that is clearly overbuilt for this Podunk area?
You realize selling is probably not going to work, and for the first time in your ownership, you begin to consider bankruptcy.
As you sit and ponder your fate, you invariably find yourself asking, "How did this happen? How did I let myself get into this position?" And the answer comes almost immediately:
The acrobats sent false signals to the market (which in this case, was you).
How could you know these signals weren't real? You really couldn't. Sure, you could have kept the hotel the same size, but you would have been turning away
an awful lot of business if you had. Who can blame you for expanding?
Expansion was what the environment seemed to call for.
(Continued, next page)