Do You Know Why Stock Prices Are So High?

Do You Know Why Stock Prices Are So High?

To millions of American investors, the bull market in stocks of the past few years has added billions of dollars to their 401(k), IRA, and other retirement accounts. Most investors don’t know or care why stock markets have shot up so much, but they certainly enjoy benefiting from that run. If you take a look at the underlying causes behind that run, however, you begin to realize that things are much more precarious than they seem.

Special: Congress Is After Your IRA, 401(k) and TSP

The root cause, of course, to the bull market in stocks has been the Federal Reserve’s loose monetary policy. Ever since the financial crisis the Fed’s monetary policy has been even looser than normal, with trillions of dollars being added to the monetary base, resulting in even more trillions of dollars circulating throughout the banking system, a nearly doubling of the M2 money supply. That money hasn’t just been sitting around doing nothing.

One of the things that money has been doing is buying back stocks. Remember that companies have two ways to raise funds: debt (bonds) and equity (stocks). Debt financing has traditionally had many tax advantages that equity financing does not, such as tax deductibility of interest payments. That makes it cheaper to raise money by issuing bonds than by issuing more shares of stock. And when debt is incredibly cheap, such as under the Fed’s zero interest rate policy, it makes more sense to public companies to issue cheap debt and buy back their stocks.

Buying back stocks helps boost the stock price, which helps to enrich insiders who choose to exercise their stock options, and if enough stock is bought back it can help strengthen control over the company by making sure that ownership isn’t too diluted. So many corporate stocks were being bought back that the buyback has been deemed the “mother of all credit bubbles.”

Now that interest rates are rising again, it isn’t nearly as cheap to issue debt, so the buybacks will come to a halt. That will cap upward movement of stock prices, which we’re already seeing this year as markets have largely floundered since hitting all-time highs earlier this year. And as interest rates continue to rise it will become more expensive for companies to continue to issue and pay debt, which could lead to significant funding crunches. All of that combined could have a drastic effect on the business climate and on the overall health of the economy.

That’s why, if you’re heavily invested in stocks, it’s time to start thinking about protecting your assets and hedging against a market downturn. A decline in stock prices is just a matter of when, not if. Investors who don’t take steps to guard against a decline in stock prices will end up suffering portfolio losses.

Special: IRA, 401(k) & TSP Scam

Thankfully products such as precious metals IRAs exist to allow investors to hedge against financial risk, inflation, and other economic calamities. With a gold IRA you can even roll over your existing 401(k) or IRA assets, allowing you to benefit from gold’s protective abilities while still maintaining the same tax advantages as traditional retirement accounts. So if you’re looking forward to retirement and hoping to keep your assets secure, it’s time to start looking at investing in gold.