“IS THE FED DRIVING THE STOCK MARKET OR IS IT THE FUNDAMENTALS?”
- Joshua M Brown
- March 2nd, 2013
"IS THE FED DRIVING THE STOCK MARKET OR IS IT THE FUNDAMENTALS?"
If I hear one more TV segment on this topic I will rip my hair out. It is a non-debate.
Dan Greenhaus has a good piece of research out on the topic that both Art Cashin and Joe Weisenthal have cited. Greenhaus, the chief strategist at BTIG, demonstrates how S&P earnings since the market lows of March 2009 have gone up by 129% ($43 in EPS then vs today's $98 or so). This 129% improvement in the index's earnings perfectly matches the S&P's price gain of 128%. He's saying that the gains in stocks are not being solely driven by the Fed but by profit growth and earnings per share.
He's right, so is Art, so is Joe. But the people who claim this is a Fed driven market are also right.
Because the Fed is not driving the stock market - it is driving the fundamentals that are driving the stock market. Once you make this distinction, it frees you up from a lot of the nonsense and conspiratorial scuttlebutt that passes for market commentary these days. The Fed's ZIRP policy is the most important driver of US earnings growth right now in my estimation which is what's behind the rally in share prices.
Take the bank stock sector, as represented by the XLF - the stocks underlying this index ETF demonstrate some of the most obvious effects of how the Fed is moving earnings. Keep in mind that the XLF includes 81 of the largest banks, credit card companies and insurers. The average market cap is like $80 billion - so this earnings and share price comeback is highly important to the broader market's advance. You should be aware that the financial sector represents 15.9% of the S&P right now, ranking just behind tech as the largest weight. In addition, banks make up a whopping 23% of the MidCap 400 and another 21% of the SmallCap 600.
And so when bank earnings are rising, the market's earnings are rising. This is usually accompanied by stock prices rising and multiples expanding unless we're at the tail-end of a cycle and too much improvement is already being priced in.
In 2008, the XLF components lost a combined negative .32 cents per share. In 2009, they turned it around (but just barely) earning a total of .39 cents per share. In 2010 the XLF earns $1.09 per share, followed by $1.14 in 2011 and $1.21 last year. In 2012, the S&P's operating earnings per share grew by 4.5% but for the financial sector, operating EPS were up almost triple that at +14%. Better capital markets and housing markets and some pockets of increasing economic activity enabled this - but Federal Reserve liquidity has its fingerprints all over the place.
Thanks to multiple expansion for the biggest components of the XLF and rapidly increasing dividends and buybacks, you can clearly understand why banks were able to make such a huge contribution to the market's continuing comeback. You can also see, if you understand how banks borrow and lend, that this is almost entirely thanks to the Fed's assistance.
So the Fed is not running around buying stocks - but the Fed is influencing the fundamentals of stocks - and, as a result, institutions are buying. On top of this effect, the Fed is also simultaneously making the alternatives to stocks less palatable with interest rate intervention and its own yield-dampening bond purchase programs.
Whether or not the Fed is driving the market is not a real argument - WE KNOW EMPHATICALLY THAT IT IS. The only question that matters is for how much longer will this continue and what happens when it does not?
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The Reformed Broker is a blog about financial markets and the economy. Joshua Brown is a New York City-based investment advisor for high net worth individuals, charitable foundations, retirement plans and corporations... More.