The Fed is Not to Blame for the Falling Stock Market

Just a quick note on this Christmas Eve.  The US stock markets are falling.  The bull market that had started in March 2009, two months after Obama took office, and which then continued through to the end of Obama’s two terms, may be close to an end.  A bear market is commonly defined as one where the S&P500 index (a broad stock market index that most professionals use) has fallen by 20% or more from its previous peak.  As of the close of the markets this December 24, the S&P500 index is 19.8% below the peak it had reached on September 20.  The NASDAQ index is already in bear market territory, as it is 23.6% lower than its previous peak.  And the Dow Jones Industrial average is also close, at a fall of 18.8% from its previous peak.

Trump is blaming the Fed for this.  The Fed has indeed been raising interest rates, since 2015.  The Fed had kept interest rates at close to zero since the financial collapse in 2008 at the end of the Bush administration in order to spur a recovery.  And it had to keep interest rates low for an especially long time as fiscal policy turned from expansionary, in 2009/10, to contractionary, as the Republican Congress elected in 2010 forced through cuts in government spending even though employment had not yet then fully recovered.

Employment did eventually recover, so the Fed could start to bring interest rates back to more normal levels.  This began in late 2015 with an increase in the Fed’s target for the federal funds rate from the previous range of 0% to 0.25%, to a target range of 0.25% to 0.50%.  The federal funds rate is the rate at which banks borrow or lend federal funds (funds on deposit at the Fed) to each other, so that the banks can meet their deposit reserve requirements.  And the funds are borrowed and lent for literally just one night (even though the rates are quoted on an annualized basis).  The Fed manages this by buying and selling US Treasury bills on the open market (thus loosening or tightening liquidity), to keep the federal funds rate within the targeted range.

Since the 2015 increase, the Fed has steadily raised its target for the federal funds rate to the current range of 2.25% to 2.50%.  It raised the target range once in 2016, three times in 2017, and four times in 2018, always in increments of 0.25% points.  The market has never been surprised.  With unemployment having fallen to 5.0% in late 2015, and to just 3.7% now, this is exactly one would expect the Fed to do.

The path is shown in blue in the chart at the top of this post.  The path is for the top end of the target range for the rate, which is the figure most analysts focus on.  And the bottom end will always be 0.25% points below it.  The chart then shows in red the path for the S&P500 index.  For ease of comparison to the path for the federal funds rate, I have rescaled the S&P500 index to 1.0 for March 16, 2017 (the day the Fed raised the target federal funds rate to a ceiling of 1.0%), and then rescaled around that March 16, 2017, value to roughly follow the path of the federal funds rate.  (The underlying data were all drawn from FRED, the economic database maintained by the Federal Reserve Bank of St. Louis.  The data points are daily, for each day the markets were open, and the S&P 500 is as of the daily market close.)

Those paths were roughly similar up to September 2018, and only then did they diverge.  That is, the Fed has been raising interest rates for several years now, and the stock market was also steadily rising.  Increases in the federal funds rate by the Fed in those years did not cause the stock market to fall.  It is disingenuous to claim that it has now.

Why is the stock market now falling then?  While only fools claim to know with certainty what the stock market will do, or why it has moved as it has, Trump’s claim that it is all the Fed’s fault has no basis.  The Fed has been raising interest rates since 2015.  Rather, Trump should be looking at his own administration, capped over the last few days with the stunning incompetence of his Treasury Secretary, Steven Mnuchin.  With a perceived need to “do something” (probably at Trump’s instigation), Mnuchin made a big show of calling on Sunday the heads of the six largest US banks asking if they were fine (they were, at least until they got such calls, and might then have been left wondering whether the Treasury Secretary knew something that they didn’t), and then organizing a meeting of the “Plunge Protection Team” on Monday, Christmas Eve. This all created the sense of an administration in panic.

This comes on top of the reports over the weekend that Trump wants to fire the Chairman of the Fed, Jerome Powell.  Trump had appointed Powell just last year.  Nor would it be legal to fire him (and no president ever has), although some may dispute that.  Finally, and adding to the sense of chaos, a major part of the federal government is on shutdown starting from last Friday night, as Trump refused to approve a budget extension unless he could also get funding to build a border wall.  As of today, it does not appear this will end until some time after January 1.

But it is not just these recent events which may have affected the markets.  After all, the S&P500 index peaked on September 20.  Rather, one must look at the overall mismanagement of economic policy under Trump, perhaps most importantly with the massive tax cut to corporations and the wealthy of last December.  While a corporate tax cut will lead to higher after-tax corporate profits, all else being equal, all else will not be equal.  The cuts have also contributed to a large and growing fiscal deficit, to a size that is unprecedented (even as a share of GDP) during a time of full employment (other than during World War II).  A federal deficit which is already high when times are good will be massive when the next downturn comes.  This will then constrain our ability to address that downturn.

Plus there are other issues, such as the trade wars that Trump appears to take personal pride in, and the reversal of the regulatory reforms put in place after the 2008 economic and financial collapse in order not to repeat the mistakes that led to that crisis.

What will happen to the stock market now?  I really do not know.  Perhaps it will recover from these levels.  But with the mismanagement of economic policy seen in this administration, and a president who acts on whim and is unwilling to listen, it would not be a surprise to see a further fall.  Just don’t try to shift the blame to the Fed.

The Obama Bull Market Rally on Its Fifth Anniversary

S&P 500 Index, March 9, 2009, to March 10, 2014

Bull Markets, 1940-2014, updated to March 10, 2014

 
   Bull Market Rallies Since 1940
  Ranked by overall growth in real terms
Start Date End   Date Calendar Days Nominal % Change Real % Change Real Rate of Growth
Dec 4, 1987 Mar 24, 2000 4,494 582% 361% 13%
Jun 13, 1949 Aug 2, 1956 2,607 267% 222% 18%
Aug 12, 1982 Aug 25, 1987 1,839 229% 181% 23%
Mar 9, 2009 Mar 10, 2014 1,827 177% 151% 20%
Apr 28, 1942 May 29, 1946 1,492 158% 124% 22%
Oct 22, 1957 Dec 12, 1961 1,512 86% 76% 15%
Oct 9, 2002 Oct 9, 2007 1,826 101% 75% 12%
Jun 26, 1962 Feb 9, 1966 1,324 80% 69% 16%
May 26, 1970 Jan 11, 1973 961 74% 57% 19%
Oct 6, 1966 Nov 29, 1968 785 48% 37% 16%
Oct 3, 1974 Nov 28, 1980 2,248 126% 34% 5%

Today marks the fifth anniversary of the Obama bull market rally.  The rally began on March 9, 2009, just six weeks after Obama was inaugurated.  A reader of this blog suggested that on this anniversary, an update of previous posts on the strong performance of the stock market during Obama’s tenure (see here and here) might therefore be timely and of interest.

Stock market prices have indeed continued to rise, and as the table above shows, stocks during Obama’s term in office have now posted the fourth highest gains of any stock market rally since 1940.  Market rallies are defined as at least a 25% rise in the S&P 500 Index (in real terms), without a 20% fall.  Equity prices (as measured by the S&P 500) have risen by 177% in nominal terms since March 9, 2009, as of the close today.  The increase in real terms (using the CPI inflation index) has been 151%.  And since this rally is on-going, it could move further up in rank.  In addition, in just twelve more days (assuming the rally does not suddenly collapse) this rally will be the third longest in terms of calendar days of all market rallies since 1940.

It is also interesting to see how steady the upward progression has been, especially since September 2011.  This is shown in the graph at the top of this post.  I do not believe anyone had predicted this.

The rally could also end tomorrow.  All rallies eventually come to an end, and this one will as well.  But the rise in prices already achieved, the fourth largest since 1940, needs to be recognized.

Should Obama be given credit for this historic market rally?  Not fully.  I doubt that equity prices in themselves are a primary objective of what Obama has been trying to achieve.   Rather, the objective has been a stronger economy.  Regulatory as well as policy measures have been taken with the aim of strengthening the system, and this ultimately benefits business (as well as the population) as a whole.  This then helps equity prices.  Unfortunately, and as this blog has discussed in earlier posts, fiscal drag from cuts in government spending has held back the pace of the recovery, and this fiscal drag is continuing.  The economy could be doing better.  Nevertheless, there has been a partial recovery.  But it is not yet complete, nor as rapid as one would have had without the fiscal drag.

But what this strong growth in the stock market does clearly indicate is that the charges by Republican politicians that Obama has been bad for business (indeed a disaster for business many of them have said), has no basis.  If there were any truth to the charge, stock market prices would not be up by 177% in nominal terms (and by 151% in real terms) over the last five years, leading to the fourth biggest rally in stock prices in three-quarters of a century.

The Obama Bull Market in Equity Prices Continues

S&P500 Index, March 9, 2009, to Nov 19, 2013

.

   Bull Market Rallies Since 1940
  Ranked by overall growth in real terms
    Nominal % Real % Real Rate
Start Date End Date Change Change of Growth
Dec 4, 1987 Mar 24, 2000 582% 361% 13%
Jun 13, 1949 Aug 2, 1956 267% 222% 18%
Aug 12, 1982 Aug 25, 1987 229% 181% 23%
Mar 9, 2009 Nov 15, 2013 166% 141% 21%
Apr 28, 1942 May 29, 1946 158% 124% 22%
Oct 22, 1957 Dec 12, 1961 86% 76% 15%
Oct 9, 2002 Oct 9, 2007 101% 75% 12%
Jun 26, 1962 Feb 9, 1966 80% 69% 16%
May 26, 1970 Jan 11, 1973 74% 57% 19%
Oct 6, 1966 Nov 29, 1968 48% 37% 16%
Oct 3, 1974 Nov 28, 1980 126% 34% 5%
         

Equity prices reached record levels on November 18, with the S&P 500 index hitting 1,800 in mid-day trading and the Dow Jones Industrial Average hitting 16,000, before both closed lower.  While any such index numbers are arbitrary, it might be timely for a brief update of a blog post from March of this year on the boom in equity prices, to see where things now stand.  That blog post noted that equity prices have boomed under Obama, to the extent that the stock market rally that began soon after he took office has been one of the largest of the last seven decades.

Since March, that rally in equity prices has continued.  The graph at the top of this post shows the path for the S&P 500 stock market index (a capitalization-weighted index that is generally taken as the benchmark for the market), from its trough on March 9, 2009, to its most recent peak (in terms of its daily closing price) on November 15.  It has now increased by 166% in nominal terms, and by 141% in real terms, since that low-point just six weeks after Obama was inaugurated.

The table above fits the on-going rally into all the bull market rallies since 1940.  These rallies are defined as increases in equity prices of 25% or more in nominal terms before ending with a correction of 20% or more.  The calculations are based on figures originally provided by Barry Ritholtz on his web site (which were in turn based on Merrill-Lynch figures), which were used in my March blog post.

There have been 11 such rallies since 1940, and the Obama market rally is now the fourth largest among these.  Since it is still on-going, it could also move up further in rank.  And the pace of the increase has been rapid.  The real rate of growth in equity prices over the course of this rally (of 21% per annum up to this point) is the third highest of any of these rallies.

Conservatives continue to charge that Obama’s policies have been terrible for business and for the economy.  Yet if that were true, one would not expect equity prices to be booming.  I should hasten to add that this rally could, of course, end tomorrow.  Stock market rallies always come to an end.  But until it does, it is hard to reconcile the view of conservatives that Obama has been bad for business with what we see happening in the markets.

The Obama Bull Market Rally in Equity Prices: One of the Biggest of the Last Seven Decades

Bull Markets, 1940-2013

 Bull Market Rallies Since 1940
  Ranked by overall growth in real terms
    Nominal % Real % Real Rate
Start Date End Date Change Change of Growth
Dec 4, 1987 Mar 24, 2000 582% 361% 13%
Jun 13, 1949 Aug 2, 1956 267% 222% 18%
Aug 12, 1982 Aug 25, 1987 229% 181% 23%
Apr 28, 1942 May 29, 1946 158% 124% 22%
Mar 9, 2009 Mar 15, 2013 131% 112% 21%
Oct 22, 1957 Dec 12, 1961 86% 76% 15%
Oct 9, 2002 Oct 9, 2007 101% 75% 12%
Jun 26, 1962 Feb 9, 1966 80% 69% 16%
May 26, 1970 Jan 11, 1973 74% 57% 19%
Oct 6, 1966 Nov 29, 1968 48% 37% 16%
Oct 3, 1974 Nov 28, 1980 126% 34% 5%
 

Obama has been called a socialist by his conservative critics.  He has been deemed anti-business and anti-private profit.  Were this the case, business would be suffering and equity prices would be depressed.  Yet corporate profits are now at record highs.  This was shown and discussed in an earlier post on this blog.  More recent figures are following the same upward trend, and are available in the National Income and Product Accounts produced by the BEA of the US Department of Commerce.

With profits at record highs, it will be a surprise only to those conservative critics that the stock market has been booming under Obama.  But what few might realize is the extent of the rally under Obama.  The current stock market rally is already the fifth largest of any stock market rally since 1940.  It is also still underway, while the others of course are not, so it may well move up in rank.

The chart and table above show the numbers.  The underlying figures were compiled by Merrill Lynch, and are available at the financial blog of Barry Ritholtz (the Merrill Lynch study itself appears to be available only privately to its clients, like much of the research of such brokerages).  For the numbers above I determined also the figures controlling for inflation (the originals were only in nominal terms), using the monthly CPI for the inflation index (from the BLS via FRED), and then ranked the rallies by the total returns in real terms.  I also updated the figures on the current rally to the numbers at market close on March 15.  The rallies shown are all those since 1940 (a total of 11) in which there was at least a 25% gain in nominal terms, which ended with a fall (a “correction”, as investors like to say) of at least 20%.

As noted, the Obama rally currently ranks number five on this list.  It began on March 9, 2009 (only six weeks from Obama’s inauguration on January 20), and as of Friday, March 15, 2013, the S&P 500 was 112% higher (in real terms) than where it was at the start.  Also noteworthy is the real rate of growth of 21% (at an annualized rate) over this four year period.  Of the 11 stock market rallies since 1940, this was the third fastest rate of growth, and only slightly below the rate of growth of the two faster rallies.

Depending on how long the current rally continues, the Obama bull market could well move up in rank.  While the market fell a bit on Friday as well as on Monday and was basically flat today (Tuesday), prior to that it had risen for 10 straight days.  This was the longest such daily streak since 1996.  While no one can predict what will happen to this rally, the increase achieved is already one for the records.

The assertions of the conservative critics that Obama is anti-business and has taken actions that suppress profits are therefore simply inconsistent with what the markets are telling us.  If this criticism of Obama had any basis, one would not be seeing such a rally in the markets.  Conservatives argue that the markets cannot be fooled, but here they are themselves ignoring what the markets are saying.

Of greater concern is not what has happened to profits, and share prices that reflected those profits, but rather what has happened to workers and their wages.  Unemployment is still high, at 7.7%.  While down from the peak of 10.0% reached in 2009 following the economic and financial collapse at the end of the Bush administration, a 7.7% unemployment rate is still well above the 5 to 6% rate one would see when the economy is at or close to full employment (there is always some unemployment, due to various frictions and mis-matches).  The recovery has been weak, and as has been discussed before in this blog, the weak recovery can be explained by the continued fiscal drag from cuts in government expenditures.

With the still high unemployment, it should not be surprising that workers have not had the power to bargain for substantial wage increases.  As was shown in the chart at the top of the recent post in this blog on the minimum wage, real compensation of workers has been flat to falling in recent years.  Yet as also seen in that chart, labor productivity has continued to rise.  With rising productivity but flat to falling wages, profits will rise.  Hence the economy has been good for profits and for a rising stock market.

The basic issue is that despite the assertions of the conservative critics that Obama has been fundamentally altering our economic structure, the truth is that Obama has not.  This is still an economy where wages have been depressed, rising well less than productivity growth since the 1980s.  Real average labor compensation (which includes both wages as well as compensation via benefits such as health insurance and pension plans) rose only by 35% between 1980 and 2012 (see the chart at the blog post cited above), for a growth rate of slightly below 1.0% a year.  But labor productivity grew by 86% over this period.  With productivity up, but wages almost flat, profits are far up.  And with profits mostly going to the already rich, the distribution of income has deteriorated sharply since Reagan was president.

Obama’s policies have not been bad for profits nor for the stock market.  The stock market rally is already one of the biggest since 1940, and is not yet over.  There is no evidence for the assertion that Obama has fundamentally changed the economic structure, to the detriment of business.  The problem, rather, is that Obama has not changed that structure.  As a result, and as has been the case since around 1980, labor has not been able to share fully in the gains from the growth in labor productivity.