Thoughts on the Wall Street / Main Street disconnect

First, a disclaimer: I’m not a stock market expert and NO ONE should take my thoughts on stock values as a basis for ANY type of trading.

I remember where I was when the Dow peaked in early October 2007. I was working out on the stepper at the Habersham YMCA, watching CNN and reading the captions (no ear pieces), as analysts rhapsodized about the long bull market and the run up above 14,000.

“What is going on?” I asked myself over and over. By that point, it was clear — and not just to me — that the housing bubble was bursting and that there would be negative fallout from that for years. The surge in stocks also seemed completely out of whack with basic economic data, which even at that point suggested that we were about to dive into recession.

Eventually, as we all know far too well, the practical woes of Main Street caught up with Wall Street. And, as it turned out, those Main Street woes were due in large measure to Wall Street.

Here’s the Dow over the last 5 years:

Yes, we’re still down from that October 07 peak, but we’re actually up from 5 years ago — almost 13%. Over the last couple of years, we’ve seen stocks on a pretty incredible run.

But job growth is anemic. We’ve seen the labor force participation rate fall and unemployment is still 9.2%. We have an aging population and an unsustainable structural deficit that’s been fueling the debt for a decade. So why then, even after a bad couple of days, is the Dow up more than 20% over the last year?

I think many armchair economists (I’m one) and many ideologically right-wing economists have not appreciated how much the Fed’s second round of quantitative easing helped buoy stocks. Ben Bernanke even occasionally said directly that supporting stock prices was one intent of QE2. I think he meant to say that the boost to the economy had translated into higher stocks, but I’m not the only one who thinks the causal flow might be more the other way: big injections from the Fed fueled stock prices, which in turn helped the general economy and broader measures of confidence.

Well, QE2 is over, and I don’t expect another round. Europe’s sovereign debt crisis hammered U.S. stocks today — and that crisis is far from over. There’s serious talk of allowing Greece to default on a significant portion of its debt and now there’s fear that Italy — the 3rd largest economy in the Euro zone — will be engulfed in the crisis. Fears about Europe don’t seem to have done too much damage to American stocks, at least not until today, when the Dow fell 1.2%, the Nasdaq 2%, and the S&P 500 1.8%. As I write this, Asian markets are all down more than 1%. Regarding the crisis in Europe, commentators are using words like “contagion” and “spread” and “containment” — as if this is a modern-day bubonic plague, or maybe just one big zombie movie.

Speaking of zombies, the U.S. banking crisis is nowhere near over. There are over 1,000 banks known to be — still — under some sort of FDIC scrutiny. And hidden in today’s news is concern that Bank of America could once again lack sufficient capital.

I’m feeling a lot like I felt in October 2007.