“How can this rally keep going?  Surely we have to roll over at some point soon.”  Those are some of the comments I’ve been getting lately.  Let’s examine some of the facts for a minute.

We’ve been rallying for over a year now without a correction of 10% or more.  We’ve had two corrections that have come close and certainly there have been plenty of stocks that have corrected much more than 10%.  But, the indices haven’t corrected 10%.  The Fed’s printing money and adding liquidity to the system at an alarming rate.  The monetary base has increased over 150% in the last year and a half.  This is after going up on average about 6% per year since the 1960s (see below).

After looking at this picture, you’d think inflation was just around the corner.  To get some of those “bad assets” off the balance sheets of banks, the Fed has been printing money and buying those assets from the bank.  That puts a lot of cash on the banks’ balance sheets and puts the “bad assets” on the Fed’s balance sheet.  In turn, the bank is supposed to turn around and loan that money out.  Usually, they’d lend out 8-10 times that amount.  That’s how money is created and in turn what could cause inflation.  But, what are the banks actually doing?  They’re not lending it to you.  That’s too risky (in their eyes, not mine )  Therefore, they are depositing that money back at the Fed or just plain hoarding it.  Which leads to the next picture.

Above is a picture of the money multiplier.  This is a measure of how much the money supply changes in response to a change in the monetary base.  As you can see, it’s actually falling and below 1.00.  It’s currently at .786.  What’s actually happening is that the Fed printing more money is having a negative effect.  That means less inflation right now which in turn means lower interest rates and in turn means higher stocks (hence no position in TBT.)

So far, we’ve established the stock market is mature and hasn’t really corrected in a year and interest rates are low and probably staying low for longer than we all thought they would.

Next comes sentiment.  Everyone I talk to these days is confused and is sitting on the sidelines or is very timid and has very little in the market.  So, overall sentiment isn’t overheated based on my interaction with real investors.  This translates into lots of cash on the sidelines just waiting to come in and buy stocks.  When will that happen?  Probably when higher prices present themselves.  Once the train leaving the station mentality is firmly in place, stocks will have a blow off top with heavy volume and down we’ll go.  We’re not there now.  Right now, there is an appropriate amount of fear and doubt.

What about the economy?  Surely, it’s weak.  Nope.  The economy is still getting stronger and while the intensity of the recover will probably fall over the next few months, the economy is still improving.  That’s the key.  Leading indicators are still pointing in the right direction and with that there’s no real inflation.

How about breadth?  A healthy market is one where lots of sectors are participating.  Look at the charts and the stats.  The rally has been spreading out.  Everyone’s joining in the party.  Small caps, mid caps, technology, energy, etc.  Bull markets don’t turn into bear markets when the majority of the stock market is going up.  In fact, the percentage of stocks above their 40-day moving average on the NYSE is currently at 84%.  In a nutshell, that means almost every stock on the NYSE is heading in a direction that is up.

What about supply and demand?  Nobody wants to sell and there are plenty of buyers.  Normally, you’d think as the market moves up, more investors would be anxious to sell those winning positions.  Not right now.  As we go up, more demand is appearing and supply is diminishing.

Combine all these various measures and this market should be bought on dips.  I’ll be careful of a short-term pullback but I’m buying the dips.

The fear of deficits, the fear of inflation and rising rates, the fear of politics.  That’s the wall of worry that turns into profits for us.