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Please pardon my late reply, but I find this an interesting subject to think about.

I somewhat agree with you, FM. At some level, the stock market does reflect the overall economy. Kind of. I think it's more correct to say that the stock market reflects corporate profits rather than the economy. There's a bit of freedom for those two to differ. Corporate profits are probably going to be higher in a good economy, and probably going to be lower in a bad economy.

For example, a particular company might have excellent economics, with good sales at a good markup to costs. But if high level employees pay out too much of that money stream to themselves, corporate profits will suffer in spite of the good economics.

Another source of disconnect - and the one that I think is currently at work - is the actions of the federal government. Back in 2007-2009 as the economy was tanking, the government chose to bail out some businesses. Investors shared in the pain of course, but some were spared from a complete wipe out of their investment. This planted the seed of the idea that corporate losses might, in the right circumstances, be nationalized rather than completely borne by investors.

How does that affect a rational investor's view of the future? Well, if they believe they are investing in the "right" kind of business - a business whose losses might be at least partially nationalized - that makes the stock of that company a bit more valuable. The investor's risk of loss is lowered. Yes, if things get bad in the economy, they could suffer some loss. But those "right" businesses might be spared bankruptcy. The investor has a lower probability of their investment going to zero.

It's like looking at two identical businesses - same products, same facilities, same everything. But one business has an agreement with an outside party to step in and keep the business afloat under certain bad economic conditions. The other does not. Which business will command a higher stock price? The one with that agreement, of course.

I believe this is exactly where we are today. When it became apparent that the coronavirus pandemic was going to be costly to businesses, the government stepped in and provided some support to businesses. That kept some businesses in business instead of going bankrupt.

Now that similar actions to support businesses during hard economic times has happened twice, investors expect that to happen again in the future. In their analysis, the probability of losing everything has been lowered. That, by itself, makes businesses more valuable to investors.

And under the assumption that the stock market bears at least some resemblance to the standard microeconomic model of supply and demand (the good ol' X on the chalkboard) buyers/investors are willing to pay a bit more under these new conditions than they were before.

I believe this at least partially explains the unusually strong stock market over the last decade as well as the last 5 months.

I don't disagree with you that we might also be in a bit of a stock market bubble. I suspect we are. But that bubble may not be as big as many think.

--Peter
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