A new study has suggested that Federal Reserve (the US’s central bank) monetary policy has served as the primary influence of American stock market activity since 2008. Htet Tayza discusses the implications of this study for the global economy.
Noted economist Brian Barnier has released the findings of his latest study. Here, he looked at the Standard & Poor (S&P) 500. This is an index of 500 publicly listed companies which serves as a leading indicator of US equities. Barnier found that multi-year bull runs in the US stock market, where prices rise or are expected to rise, can be attributed to a single influencing factor each time.
Reporting on the story, Yahoo Finance explained how Barnier reached this conclusion. First, he compiled statistics concerning the total value of publicly-traded American stocks since 1950. Then, the economist divided this value by another economic factor, graphing the ratio of each one. Barnier used these observations to draw up a visual analysis chart.
Yahoo Finance writes “If the chart showed horizontal lines stretching over long periods of time, that meant both the numerator (stock values) and the denominator (the other factor) were moving at the same rate.” In other words, if the numerator and denominator move at the same rate, it suggests that the factor in question drove stock market activity during a specific period of time.
Barnier looked at hundreds of factors to determine the primary influencers of bull market activity. He whittled it down to four factors, which at different points throughout the last seven decades have each acted as the single biggest driver of the US stock market. These influencers were future gross domestic product (GDP) outlook, household and non-profit liabilities, open market paper and the Fed’s assets.
From the end of World War Two until the mid-1970s, future GDP accounted for 90% of stock market movements. The rise of consumer debt, especially home mortgages, allowed household liabilities to account for 95% of stock market movements from the mid-70s until the real estate crash of the early 1990s, according to Barnier’s research.
From mid-90s to the early 2000s, the tech bubble drove the stock market. However, the commercial paper sector also saw heightened activity during this period, suggesting that this market may have accounted for as much as 97% of the US tech bubble. As this bubble burst, Barnier notes that the housing bubble began, driving 94% of the markets movements from the early 2000s to 2008.
Influence of Fed policy
2008 was the year that the housing bubble burst, due to the US financial crisis. The Fed initiated a policy of “quantitative easing” (QE), to help the US economy recover. Following three years of QE, which saw the central bank flood billions of dollars into the US bond market every month, the Fed’s balance sheet increased from US$2.1 trillion to US$4.5 trillion. Consequently interest rates dropped dramatically, as bond yields and bond prices moved in the opposite direction.
During this period (from November 2008 – October 2014) the S&P 500 doubled in value. Barnier explained that this means that the Fed’s monetary policy drove 93% of market movement from the beginning of the QE programme until the present day. He also noted that since the end of QE in late 2014, the S&P 500 has remained stable, adding that investors need to determine what will be the next driver of bull market movement.
Speaking on this, Barnier said: “Quantitative easing has stopped, but now we’re into the interest rate world… That means for any investor trying to figure out what to do, step one is starting with a macro strategy.” In December 2015 the Fed rose its benchmark interest rate, which it held down for years to promote US economic growth, to between 0.25% and 0.5%. According to Market Watch, the S&P 500 rose by 1.5% following the Fed’s announcement.
Implications for global investors
In modern times, the Federal Reserve’s policy has had a significant effect on the US stock market. Since stocks indicate how well a company is doing, the stock market often serves as a key indicator of the health of the overall American economy. Because the US dollar is used in most international transactions, US economic activity usually has a significant impact on the global economy at large.
Therefore, the implications of this study are clear. By influencing the US stock market, Federal Reserve policy can have a significant impact on the global economy. Investors may need to keep a close eye on the central bank’s benchmark interest rate. If the Federal Reserve chooses to raise this rate once more, the effects of their decision could ripple out across the world.