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Rising Stocks: A “Fake Rally” or Just Supply & Demand?

Rising Stocks: A “Fake Rally” or Just Supply & Demand?

Here's what you need to know about economics: the price of everything is determined by supply and demand. There are no exceptions to the relationship between supply, demand, and price. By logical extension there is no such thing as a "fake price."

That doesn't mean prices can't be manipulated. It means that such manipulation requires either soaking up supply (e.g., the Fed buying $85 billion a month of paper) or increasing demand (e.g., paying $200 for a dozen roses because it's Valentine's Day).

If you're looking for a unifying theory to explain the stock market rally consider this: buybacks. According to FactSet, year over year buybacks by dollar value increased roughly 10% last year. In fact, $384 billion of shares were repurchased last year. There were about $40 billion worth of IPOs in 2012. Simply put, supply of shares is shrinking.

Demand for stocks is rising. Stock inflows are rising. It doesn't matter why you think that may be. It's simply math. Money is going into equities. Demand is growing.

"You're getting actually a shortage of stocks and too much liquidity not just from the Federal Reserve but all over the planet right now," says Jeff Saut of Raymond James in the attached video.

From this simple premise the debate about why the market is where it sits today becomes much more complicated, often pointlessly so. Stocks are supposed to be priced based on discounted cash flows derived from future earnings streams discounted to account for the risk taken by equity stakeholders compared to return on risk-free assets. There is little to no evidence to support this method of pricing as it applies to equities but that's the theory.

When people have an appetite for that which is scarce, prices rise. If you think that's "stupid," it's your own business. If you think prices are fake you're wrong. I can sell every stock in my portfolio for within 1% of the price you see quoted. That's fact. Everything else is opinion.