Stock Prices: The Fed Is Manipulating the Numbers

May 30, 2013

Three rounds of quantitative easing (QE) by the Federal Reserve have produced record-high stock prices, but real economic growth still remains below the levels expected in an economic recovery. An encouraging uptick in housing prices and the gradual decline of the unemployment rate have helped bolster household wealth and consumer spending, but with fiscal tightening weighing on economic growth, inflation falling and corporate earnings flat, the current rise in stock prices is unsustainable, says John H. Makin, a resident scholar at the American Enterprise Institute.

  • Increases in stock prices are far outpacing growth in the real economy and may be headed for a midyear swoon, despite the encouraging housing sector and employment growth.
  • Fiscal tightening is being partially offset by higher household wealth, but a midyear growth slowdown still seems likely.
  • As evidenced by past patterns, another round of quantitative easing from the Federal Reserve is unlikely to boost stock prices and economic growth in the long term.

U.S. first-quarter 2013 growth of 2.5 percent was below expectations and could be revised up or down. Yet, the strong 46 percent annualized first-quarter growth rate of the S&P essentially repeated the pattern of the last four years: Stocks rise sharply, seemingly predicting the advent of a strong recovery. But then at midyear, during the second or third quarter (or both), growth slows sharply and stocks fall sharply only to be revived by a new round of QE.

The percent annualized rise in the S&P during this year's first quarter and the subsequent rise during early May have been among the largest since 2009 and have taken the index to a record high above 1,650, surpassing the pre-Lehman Brothers collapse high in October 2007 of 1,550.

  • The rise in stock prices is partly attributable to aggressive buybacks of stock by cash-rich companies.
  • Yet, earnings, while good, are on average flat relative to a year ago.
  • Although market expectations for the second-quarter growth rate are about 2.5 percent, the same as the first quarter, there are sound reasons to believe that the stock market may be predicting the fourth sustainable recovery in the last four years of failed sustainable recoveries.

The pattern that appears to be playing out again this year has become so familiar that the term "annual swoon" has entered the vernacular of daily news market commentary to describe the outlook for stocks if the economy underperforms. The Fed can't keep using quantitative easing to manufacture high stock prices -- it will never be sustainable.

Source: John H. Makin, "The Fed Can't Save the Stock Market Again," American Enterprise Institute, May 21, 2013.

 

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