It Is (Still) All About the Fed
I have, on many occasions in the past, warned investors not to make financial decisions based on their political biases. The majority of media commentators, it seems, didn’t hear me, or if they did hear, they didn’t listen. When you hear, see or read a debate at the moment on how quickly the economy and/or the stock market will recover, you can usually divine the politics of the participants by their stance on the issue. Republicans generally argue that things will be back to normal quickly, while Democrats are more circumspect.
Both sides seem to believe that the rate of economic recovery is dependent upon the party affiliation of the current White House resident. Both sides are wrong. If we look back on the history of the stock market since the last crash ended in 2009 it is clear that whatever the political landscape, the biggest influence on the market was not the President or Congress, it was the Fed.
An annotated chart for the S&P 500 ETF (SPY) since the depths of the 2008/9 credit crisis makes interesting reading. The recovery has been maintained since March of ’09, regardless of who was in power. When that recovery has been derailed temporarily, it has mostly been shortly after the Fed tightened their policy, either by ending a QE program or, at the end of 2015, attempting to “normalize” by hiking rates.
If the “politics is king” crowd were right, that couldn’t have happened. Either Obama’s “socialist attacks on business” or Trump’s “incompetence and propensity for bankruptcy” would have derailed the recovery. They didn’t though, and the only thing the market responded to was what the Fed was doing.
That should really come as no surprise.
It is often lost on people, but the primary influence on the stock market, as with any market, is supply and demand. In this case, it is supply of investable instruments and demand for them. What we have seen pretty consistently over the last ten years is supply being reduced as demand has increased.
The reduction in supply is attributable to two things. First, share buybacks have become a thing. A combination of the recovery, exceptionally low interest rates, and a lack of appetite for long-term investment left businesses with a lot of cash and access to a lot of cheap money. If a corporation’s primary duty is to enhance shareholder value, then forcing up the stock price by buying back shares in that environment makes perfect sense.
The Fed also contributed to the lack of supply. Their massive purchases of bonds took a lot of investable assets out of the market and artificially increased demand for what was left.
Meanwhile, as those actions reduced supply, the Fed was also busy creating demand. As QE took assets off the market, it replaced them with a lot of cash. One of the most basic fundamentals of investing is that cash seeks a return, and with limited assets to buy on the credit side and yields on bonds at historic lows, stocks become valuable regardless of fundamentals.
All of that was happening throughout most of the Obama Presidency and in the first three years under Trump, but it was to some extent hidden by gradual expansion of the economy. Unemployment has been falling pretty consistently for a decade, and GDP has grown pretty consistently during that time, if more slowly than most would like.
At least that was true until a couple of months ago.
Initially there were many (and I was one of them) who, hardened by previous virus scares that had a limited effect on the U.S., such as Ebola, SARS and MERS, believed coronavirus, like those, would be a short-lived thing. It quickly became clear that this would not be true, and the countermeasures that have been taken to fight the pandemic have devastated the economy. We are in the midst of massive unemployment and an almost total economic shutdown and, while there are signs of progress, we still can’t know for sure when this will end or if there will be much permanent economic damage.
And yet when the Fed cut rates and reactivated QE, the market bounced spectacularly. That bounce has continued even as early returns in earnings season indicate an historic year on year decline in earnings and massive uncertainty about the future.
This is a free country, so if you want to believe that that is down to the leadership of a man who has advocated for a drug that had death as the primary outcome of trials, claimed total authority to act but denied any responsibility for those actions, and seemed to suggest that we should try ingesting or injecting cleaning fluids in response to the virus, that is your right.
The timing of that bounce and logical analysis, however, suggest to me that once again, it is all about the Fed.