Why is the stock market bullish while other indicators -- most notably, high unemployment and slow GDP growth -- signal that the economy isn't strong?
- Interest rates are really low. Absurdly so. That means people can't make a lot of money by lending it out (i.e., by investing in bonds or putting money in the bank). At some point or another, even people who are highly risk-averse conclude that stocks (which are "riskier" than bonds) are going to pay off either through dividends or price appreciation and become more willing to invest in stocks than they would with higher interest rates.
- Very low interest rates also allow companies to grow with a very low cost of capital. If you can borrow lots of money at a 4% or 5% interest rate, rather than 10% or 15%, then you can build or buy a lot of new capital items that leverage your profits at a very lowcost.
- Other countries around the world still look a lot riskier than the United States. Europe has a debt crisis. Russia has a strongman in the Kremlin. China hasn't gone democratic yet. And on and on.
- The stock market has already risen, which causes people to want to jump on the bandwagon. This mentality is the opposite of what Warren Buffett advises ("Be greedy when others are fearful and be fearful when others are greedy"), but it's human nature.
- Companies have better balance sheets than they've had in decades.
- Productivity keeps growing as technology lets companies make more money without having to add many new workers.
- There is a strong perception of a high risk of inflation. The Federal Reserve has put a lot of cash into the economy in the interest of stimulating it, and if they can't pull that cash out at the right time when the broader economy gets stronger, that could lead to inflation. Stocks are widely acknowledged as a better hedge against inflation than cash or bonds.
- Baby Boomers will have to sell off their stocks sooner or later.
- MV = PQ. Velocity is very low, but when it increases, it's going to create a high inflation risk.
- Tax risks. Government overspending hasn't been controlled yet. If that doesn't happen, future taxes will inevitably be much higher than anyone wants.