A Bull Market That Lasts Forever?

Stocks around the world are up, the fundamentals are improving, and over in Europe, says an August 13 Bloomberg report, the economies "...barely contracted in the second quarter as Germany and France unexpectedly returned to growth, suggesting Europe’s worst recession since World War II is coming to an end."

Inevitably, the absolute majority of analysts and investors see economic improvements as positive for the stock market. They even go one step further and say that there are "feedback loops" between the two: As the economy improves, stocks rise; as stocks rise, the economy improves -- and round and round they go. (Reverse that if the economy or stock fall.) Last summer, for example, the International Monetary Fund issued this statement (emphasis added):

"Global financial markets continue to be fragile and indicators of systemic risks remain elevated. The downside risks… [are] leading to a negative feedback loop between the financial system and the broader economy."

At first glance, the idea of "feedback loops" makes sense... but let's take a closer look. Stocks have rallied since March of this year. If the economy and stock market really work in a "loop," won't this bull phase continue forever -- literally?

Think about it. The improving fundamentals boost the economy, goes the story. In turn, the improving economy benefits the financial system and the stock market -- and they do it in a "loop": Each step higher by one creates an even higher step by the other. If you continue this logic, not only should this bull phase last forever -- it will also get progressively better as the economy and financial markets improve each other further and further.

Clearly, that's a fantasy. If "feedback loops" really existed, either a bull or a bear market would last forever: Good times would perpetuate everlasting euphoria, and bad times would propagate eternal pessimism. But in real life, we have manias and crashes, economic booms and busts. Ironically, in bull markets, the better things seem to be, the harder we fall -- just think back to the real estate crash or to the summer of 2007, when the DJIA topped amidst "the goldilocks economy." And in bear markets, the worst news usually comes just before things turn around; it's no accident that stocks bottomed in March, when most fundamentals were at their worst.

I'm not the first one to pick up on the idea that "feedback loops" between the economy and stocks are not real. Robert Prechter, Elliott Wave International's founder and president, came to this logical conclusion years ago in his Pioneering Studies in Socionomics (Chapter 27):

"I used to think that mood formed a feedback loop with events, which in turn reinforced the mood. I have since seen that this idea is erroneous. … If events formed a feedback loop with mood, then social trends would never end. Each new extreme in mood in a particular direction would cause more reinforcing actions, and those actions would reinforce that same mood, and so on forever. This is an untenable idea."

We at EWI have been forecasting the markets and the economy for 30 years, and we know that it's not "loops" that create booms and busts; people's collective emotions do. If you want real answers about the causes and likely duration of this bull phase, Elliott wave analysis has them.