One sign for the inflationists, or a sign that the top is near: financials headed back to top of S&P 500 Index

In State of play in Q32012: Fed and U.S. government policy is not enough to offset deflation, I wrote:

Not only is hyperinflation unlikely, there are even signs that we have seen the end of inflation for the time being. During the hyperinflation in Wiemar Germany, the financial sector rapidly expanded and came to dominate the economy. People were paid twice a day, and they immediately ran to the bank to cash their pay check before the value of the mark fell. Bank workers almost quadrupled from 1913 to 1923. The public also borrowed heavily and bought stocks.

In the early 1990s, right after the savings and loan crisis, financial stocks made up around 7% of the S&P 500 Index (SPY). This grew to roughly 22% at the market peak in 2007, and it has fallen to 14% recently. This growth in the financial sector occurred along with the massive $50 trillion in credit created by the economy. Credit functions like money in the economy and for this reason, if there's any comparison to Wiemar Germany, it may be the growth in debt and the financial sector from 1980 to 2008.

Interesting factoid: the financial sector is now 16.9% of the S&P 500 Index, behind technology at 17.4%. That works out to a 3% relative valuation gap; were financials to outperform technology by about 3% moving forward (which seems guaranteed based on earnings season), then financials will be back atop the S&P 500 Index sector allocation. (The number increases if technology rallies. For example, if tech advanced 12% in the next 6 months, financials would need to rally about 15.5% to overtake it.)

Amazing considering that financials were at the epicenter of the 2008 financial crisis. Ben Bernanke and the federal government have achieved the Great Delay. I believe they have re-blown the bubble and sown the seeds of the next decline, since with financials at the top of the chart, another financial crisis will have an outsized impact on the S&P 500 Index.

On that note, here's Bill Fleckenstein: Bunk from central bankers

But it is instructive to consider the modest actual amount of monetary injections, as a percentage of gross domestic product, in the mid-1920s that led to the stock bubble and, ultimately, to the bust. That stimulus was small compared with the easy money of the late 1990s that culminated with the $30 billion to $50 billion the Fed injected to protect the world from "Y2K."

Yet the sums involved in previous periods of irresponsibility are mere rounding errors nowadays.

Thus, when I contemplate the damage that will be done by four years (and counting) of quantitative easing, I just shudder at how big the disaster might be -- and there is no doubt this experiment will be a disaster.

The Fed has expanded its balance sheet to $3.5 trillion, and it now owns more than 20% of outstanding U.S. debt. Either it is going to continue buying bonds forever, which is impossible, or there is going to be a massive dislocation at some moment, because someone else is going to have to buy that debt when the Fed ultimately stops, even if it doesn't choose to sell anything (and just lets the debt run off).

There will be no painless extrication from QE and, as I have said, I don't believe the Fed will be able to leave ZIRP (zero-percent interest rate policy) willingly.

Fleckenstein goes on to quote from Paul Johnson's "Modern Times":

Domestically and internationally they constantly pumped more credit into the system, and whenever the economy showed signs of flagging they increased the dose. The most notorious occasion was in July 1927, when Strong and (Bank of England Gov. Montagu) Norman held a secret meeting of bankers at the Long Island estates of Ogden Mills, the U.S. Treasury Under-Secretary, and Mrs. Ruth Pratt, the Standard Oil heiress. Strong kept Washington in the dark and refused to let even his most senior colleagues attend. He and Norman decided on another burst of inflation and the protests of (German banker Hjalmar) Schacht and of Charles Rist, Deputy-Governor of the Bank of France, were brushed aside.