The stock market has a fever. And the only prescription is more inflation. That's the clear message from the below chart, courtesy of Reuters.
Since the recovery began in mid-2009, the S&P 500 (orange) and expected inflation (blue) have tracked each other almost perfectly. Intuitively, that might seem obvious. As inflation goes up (or down), so too do stocks, right? Actually, not always.
Consider the 1970s stagflation. Prices spiraled out of control most of the decade, but stock prices didn't. And after Paul Volcker finally succeeded in whipping inflation in the early 1980s, stocks moved in the opposite direction: They soared.
It's all about whether there is too much or too little spending in the economy. When there's too much -- like in the 1970s -- inflation isn't good for stocks. But when there's too little, stocks will take any spending they can get. Even if that extra spending comes from inflation. As Scott Sumner and Paul Krugman have pointed out, the above chart is Exhibit A in the case that the U.S. economy is suffering from a shortage in demand, above all else.
Hopefully, somebody at the Fed is listening to the stock market.