Why Wall Street Is Winning Right Now And Everyone Else Seems To Be Losing

If you’re wondering how on earth the stock market is hitting record levels while the rest of the economy barely plods along you’re not alone.

Just four years after hitting a painful low the Dow Jones Industrial Averagerallied yesterday and hit a record  14253.77 points. The previous high was hit back in October 2007 when the country was mostly blind to the upcoming financial crisis.

Since then the economy has taken a beating with stubborn unemployment levels and unimpressive GDP figures. But while neither of those two economic indicators have shown drastic improvement the financial markets are moving like it’s 2007 while the rest of the country struggles to keep its head above water. What gives?

“The stock market is a forward-looking indicator. When you buy a stock you are buying a piece of corporate America and you get to participate in the future profits of that corporation,” explains James J. Angel, associate professor of finance at Georgetown University‘s McDonough School of Business.

Angel says the market is looking ahead and sees a better economic landscape than the rest of us might see today.

“The rally is a sign that the world isn’t going to end. And that, yes, the unemployment lines is still long, but there’s a light at the end of the tunnel and the light is not just an oncoming train,” Angel adds.

And not even the threat of the budget sequester nor the fiscal cliff would have stopped this rally. That’s because the financial markets have something working directly on its side: Ben Bernanke, chairman of the Federal Reserve and printer of money.

Bernanke has a very powerful weapon. He controls how much money will make its way into the system and right now his policy is to print money in droves and push it into the markets. The Fed has pumped trillions of dollars into the markets by buying up mortgage bonds and U.S. Treasuries. WashingtonPost’s Neil Irwin explains the impact:

The investors who otherwise would have bought those bonds have to invest in something else. Maybe it’s corporate debt, maybe it’s the stock market, but either way it props up private asset prices and makes it cheaper and more desirable for companies to invest. Higher prices for stocks and other assets also has “wealth effects,” making the people who own those securities feel richer and therefore more willing to spend. It is no coincidence that the rally in the stock market over the last few days has come about following speeches by the No. 1 and No. 2 Fed officials that suggested that QE policies aren’t going away anytime soon.

The problem is that not everyone owns stocks or other assets whose prices are going up as a direct result of the Fed’s policy. According to a 2010 Fed survey of consumer finances, just 11.7% of families in the 40 to 59.9 percentile of household income own stocks and 6% of families in the 20 to 40th percentile of income own stocks. Compare that to families in the 90 to 100th percentile of income where 48% own stock.

Put simply, wealthier people tend to own more stock and so when the market rallies they are better off than the rest of the country.

The other thing the Fed’s action does is keep interest rates at record lows. That’s supposed to trigger everyone to borrow money and help spur other financial activity like mortgage refinancing. But low rates are having a negative effect on people trying to save money rather than borrow or invest it. “There are winners and losers in the low interest rate world and savers are the losers here while borrowers are winning,” Angel says.

Tony Cherin, professor of finance at San Diego State University, says it’s no surprise that the market is doing better faster than other economic indicators like manufacturing, GDP and the unemployment rate because it’s typically a leading indicator.

But just because the Dow has reached a never-before-seen level doesn’t mean it’s time to celebrate.

“I compare it to a cafe latte where underneath there are some decent fundamentals but on top there is some froth. There’s a bit of recovering happening in housing and manufacturing, for example. So there are some good signs but there are some clouds too like Europe and China,” Cherin says.

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Carl Icahn

Net worth: $20 billion
At 77, Icahn enjoyed another strong run in 2012, beating the U.S. stock market and most hedge fund managers. The investment pool he manages for himself and his employees returned 28% in 2012, thanks to bets on Hain Celestial Group and CVR Energy. Icahn, who was born in Brooklyn and grew up in Queens, returned his hedge fund’s outside money in 2011. Separately, shares of his Icahn Enterprises, which invests in rail cars, retail, gaming, and energy, surged at the start of 2013. He started 2013 by locking horns with hedge fund trader Bill Ackman over Herbalife, the nutritional supplement seller Herbalife. Icahn took a roughly 13% position in the company after taking on Ackman in a verbal slugfest on CNBC. He returned the client money he managed in his hedge fund in 2011. The activist investor announced in 2012 that he is giving $200 million to the Mount Sinai School of Medicine and has given $40 million to support his six charter schools operating in the Bronx.

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