Roughly speaking the stock market is ten times higher than it was not much more than ten years ago. It would seem that we are all a lot wealthier. In a sense we are. Each one of us can sell our stock and buy many things we could not afford before. However, we can't all do this. If a significant fraction of us tried to, our attempts to sell would drive the stock market down to where it started. Evidently, the recent stock market rise has not made us wealthier, as a group. We are simply suffering from delusions of grandeur.
Paper wealth is wealth only to the extent we can use it to buy things we like. But we can only buy things that exist. The stock market's rise has not been matched by a significant increase in the number of things that exist. There is not much more production equipment and plant. Neither is there much more of anything else that we like to have, such as cars and houses. Thus, the per capita number of things we like to have has not increased significantly. Indeed, things per capita can't change much over the short term, because it takes a lot of time to make a lot of things.
If things per capita can't increase significantly over the short term, it is plainly impossible to buy or hold significantly more things per capita over the short term. In other words, society as a whole is not wealthier just because the stock market goes up a lot over the short term, no matter how far it goes up.
If you need more convincing, consider the implications if the stock market were to rise so high that all of us were worth ten million dollars, on paper. This is enough for all of us to retire, if you believe that stock market wealth is real wealth. Suppose everybody did retire. Nobody would be working, so production would cease. Consequently, there would be nothing to consume, and consumption would cease. We would all be poor, no matter what we were worth on paper.
If a big stock market rise doesn't make us significantly wealthier, as a group, then a big stock market decline doesn't make us much poorer. So, when the crash comes, just don't read the paper, listen to the radio, or watch TV, and you'll be all right if you've avoided undue borrowing. This, of course, presumes that Government, various regulators and experts, and business leaders act sensibly. Hmm, maybe you should be a little concerned, after all. You never know what will go through these peoples' heads.
Is the stock market likely to crash, or at least have very disappointing performance? All it takes is the reverse of what made it go up so high. What was that? Simply investors' desire, on average, to have a little more of their portfolios allocated to stocks.
Consider an example. Suppose the financial market consists of $50 of cash and $50 of stock. Then total wealth is $100 and the average investor's equity allocation is 50%. Suppose the average investor decides that he wants an equity allocation of 60%. Then stocks must go up until they represent 60% of the total market. This means that stocks must rise from $50 to $75. The stock market rises 50%. This may make investors so optimistic about the stock market that they decide stocks should be 75% of their portfolios. This requires a stock market worth $150. Stocks are now up another 100%, for a total of 200% (You did catch that 50% plus 100% equals 200%, didn't you?).
At some point, investors' are satisfied with their stock allocation, and the stock market stops rising. Then, the average investor may decide the action is over. He may try to enjoy his newfound wealth, say by selling some of his stock to buy a bigger house. Put more precisely, the average investor may decide to reduce his equity allocation proportion to 60% from 75%. The stock market then drops, instantly, from $150 to $75, a decline of 50%. This happens before the average investor can sell his stock. He doesn't even get to buy his house.
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