On the day of the Federal Reserve’s announcement regarding targeted low interest rates and a new bond-buying program, the stock market started out strong, only to sell off by the end of the day. This has happened countless times over the last couple of months, and it’s a sign that this market is tired. The stock market is finally seeing through the Federal Reserve, and investors now realize that no further policy action can do anything to help U.S. employment numbers.
This has got to be one of the most accommodative Federal Reserve’s in history. On Wall Street, you couldn’t really ask for a more compliant central banker, and the artificially low interest rates are very helpful for the bond market (by bond market, I mean the system itself, not investors). Corporations are benefiting from the Federal Reserve with lower borrowing costs, but they aren’t investing in new plant and equipment. Large-cap companies are awash in cash, and it’s a lot easier for them to keep hoarding it, or return it to shareholders in the form of dividends or share buybacks. (See “More Dividend Increases Coming Soon—Is This Good or Bad?”) A lot of participants are benefiting from the Federal Reserve’s action, except for the average individual who is looking for work.
One stock market index that just can’t seem to go anywhere these days is the Dow Jones Transportation Index (or average). This index basically hasn’t done anything for the last five years, and if you believe in Dow theory, the stock market will not advance materially without confirmation from transportation stocks. This index is stuck in a rut, and the broader stock market is stuck along with it.
Chart courtesy of www.StockCharts.com
If you go to any Federal Reserve web site, or just type “M2 money supply” into any search engine, you’ll easily find a chart showing this key data set. When you look at the chart, the growth is staggering. And it all seemed to take off in 1995, just around the same time the stock market experienced one of its biggest bull runs before bursting in 2000.
An increasing money supply is not a bad thing. The M2 data set includes the M1, plus savings deposits and cash in money market funds. So as an indicator, it definitely represents the level of liquidity in the system; but in my mind, it also represents the unwillingness for participants to invest in the Main Street economy. Today, this is the real problem.
After the stock market burst in 2000, growth in the money supply kept increasing as the result of money creation by the Federal Reserve and an increase in cash deposits on the part of investors (individuals and corporations). The same thing happened during the subprime financial crisis; the M2 money supply shot up dramatically, and the Federal Reserve just kept on accommodating.
Today, interest rates are low, and this favors the stock market. Yet the stock market isn’t going up, because there is no real economic growth to be had. The Federal Reserve has done all it can (many argue too much) to increase liquidity in the marketplace, only to have this liquidity serve the interests of institutions like Wall Street and corporations, not the average person on Main Street. This is a fundamental problem facing the U.S. economy, investors, and the Federal Reserve. Corporations are sitting on mountains of cash, but they aren’t investing it in new operations because of all the uncertainty in the world, which was largely created by poor fiscal policies at the sovereign level in many mature economies.
So the Federal Reserve has done all it can with monetary policy. Governments around the world (including the U.S.) have no flexibility with fiscal policy, because of overspending and high levels of debt. So it’s a real pickle, similar to having too much credit card debt. Getting out of this cycle is going to be extremely difficult and painful. This is why dividend income from the stock market is so important going forward—you can’t expect anything else.