Whos’ Driving the Bus?

Is the Federal Reserve driving the bus or just along for the ride? The stock market rally is the result of both an accommodative Federal Reserve and improving market fundamentals. The Fed is working the bus’s accelerator pedal while the market has control of the wheel. Easy monetary policies delivered through a variety of Fed programs under the banners of Quantitative Easing (QE) and Operation Twist (OT) has definitely bolstered stock prices. Look at a graph of the expansion of the Federal Reserve balance sheet and the price movement of the S & P 500.

One can easily conclude Federal Reserve policy is having a positive impact on the equity market. This conclusion is further supported if you notice that the mini price corrections during this bull market occurred during short breaks in the Fed’s monetary expansion. While the Fed has given the market a supportive tailwind, the market is also recognizing better fundamentals. Corporate earnings are strong and continue to get stronger. Corporations are lean, employees more productive and profits are at record levels. The U.S. consumer has deleveraged, become more confident, and is spending once again. Housing is still well below pre-recession levels, but the current trend is positive. While the bearish investor will point to the chart above and claim this rally is just smoke and mirrors, the bullish investor will look at the chart below and tell you stock prices are driven by fundamentals such as the earnings per share of the S&P 500.

As this bull market approaches its fifth anniversary the debate continues; is this a Fed induced asset bubble or is an improving economy driving prices higher?

Our view is the Federal Reserve has created an environment for corporations to maximize their success, but ultimately it is the success of the companies themselves that will dictate the future direction of stock prices. We firmly believe the stock market is the best wealth creation machine ever invented, but it takes time and patience to generate wealth. It’s never a straight line and hurdles are already in place for 2014: government shutdown round two, debt ceiling debate, Fed tapering decisions, mid-term elections, geo-political events, and the future of Obamacare to name a few.

Regardless of the cause, stocks continued to run higher in November. The S&P 500 set new record highs twelve times and the NASDAQ reached the 4,000 level for the first time since 2000. November’s performance numbers were a microcosm of the trailing twelve months. U.S. Stocks lead the way, international stocks underperformed, investment grade bonds and municipal bonds posted small losses, high yield bonds were up and commodities declined yet again. For the month, the S&P 500 gained 3.05%, , NASDAQ Composite 3.79% and the MSCI Europe, Asia, Far East (EAFE) 0.43% MSCI Emerging Markets -1.46%.

Bonds gave back some of their October gains. The Barclay’s US Aggregate Bond Index returned -0.37% for the month and -1.61% for the trailing twelve months. Once again, high yield was the best monthly performing bond sector with a 0.51% return. Commodities continued their struggle as the Dow Jones Commodity index fell 0.80% during November.

Posted on December 3, 2013
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