Inflation Fears: Real or Bogus Market Mover?

Inflation Fears: Real or Bogus Market Mover?6/21/2007 6:56:46 PM
When stocks drop sharply in the course of three trading days – as they did earlier this month on June 6-8 – news commentators try to supply the reason. This time around, "inflation fears" seemed to win the lottery. However, Bob Prechter, debunks that reason in the June 15 issue of his Elliott Wave Theorist, which is excerpted for this Prechter's Market Perspective column.
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Stocks Tumble on Global Inflation Fears—June 07, 2007, Fox News
Investors are getting a case of inflation jitters —June 7, 2007, Business Week
Inflation Fears Again Chill the Markets—June 8, 2007, New York Times
Stocks decline…inflation fears citedJune 8, 2007, Atlanta Journal-Constitution
According to economists and news commentators, the stock market fell on June 6 through 8 on “inflation fears.” Charts of the S&P 500, gold, silver, the US dollar and the S&P 500 Homebuilding Index show that the stated reason for investors’ fear is utterly bogus. As stocks fell on those days, gold cracked to its lowest level since January, and silver fell as well. Did investors sell gold and silver because of inflation fears?
At the same time, the US dollar had its second-biggest two-day jump of the year. Did investors buy the dollar because of inflation fears? Real estate prices were falling as well. We can’t blame inflation fears on the fall in bond prices, which can fall either on fears of inflation or fears of default brought on by deflation. Thus there is no basis upon which to argue that fear of inflation is the fundamental reason that investors sold stocks on June 6-8.
To be sure, investors, economists and others did feel fearful on those days, but these charts prove that the reported reason for their fear cannot be the real reason. It may also well be that stock sellers said they feared inflation. But these graphs prove that any such statement on those days could have been the result only of rationalization. Fear indeed motivated investors to sell, but their fear derived from a turn—however brief—toward negative social mood, which caused investors to sell stocks, bonds, gold, silver and real estate all at the same time.
Here are more ironies.
Credit inflation, deriving from an optimistic mood, has been holding the stock market up. Stocks have risen in dollar terms since 2002, and the dollar has been weak for most of that time. So inflation has been bullish for stocks, not bearish.
A slight social mood change toward the negative has also been motivating lenders, borrowers and legislatures to curtail the expansion of credit and debt, thus acting to turn the tide – though not yet decisively – toward deflation, the very opposite of the cited reason for the stock market decline.