Stockmarket returns in America
The long arm of the Fed
The central bank may exert a strange sway over stockmarket returns
SPECULATORS have always sought ways to anticipate shifts in share prices. Once they scrutinised rail-carriage movements to get a jump on business trends. A recent paper* concludes that since 1994, a shrewd approach would have been to focus on the Federal Reserve.
It is no surprise that meetings of the Federal Open Market Committee (FOMC), in which Fed governors and regional Fed presidents set interest-rate policy, can trigger rises and falls in the stockmarket. But the study analyses a remarkable correlation. Usually every fortnight between FOMC meetings, fresh information is discussed in a gathering of Fed governors. It finds that all the gains in the stockmarket have occurred, on average, in the weeks of the FOMC meetings and the ones that involve the governors alone. A dollar invested only during those weeks would have grown more than 12-fold over the period. A dollar invested during other weeks would have lost half its value (see chart).
To check their results, the authors explored potential correlations such as company earnings and economic data. They found none that were as statistically significant. They speculate that there is a causal connection, selective disclosure, which they say is unfair. Those who attend the meetings have informal contact with the media, consultancies and financial firms, and eventually the content of those meetings makes its way to the stockmarket. Some of that is potentially valuable. The governors receive reports on the economy, banks and the financial markets, and often begin formulating what may be announced by the FOMC.
In 2012 an alleged leak from within the Fed to a publication, Medley Global Advisors, prompted an investigation by the Justice Department and Congress, which has yet to be concluded. The paper cites several non-nefarious reasons for those informal contacts: to extract information from market participants; to explain the Fed’s decision-making process; and to air competing views within the central bank. (Often board members also make their views known through speeches and interviews.)
There are questions about the significance of the correlation. Why did it not start before 1994?
Why does it not also apply to the bond market, which should be at least as sensitive to Fed policy? Why does the stockmarket always rise during the weeks in question, when Fed deliberations may cause a stockmarket sell-off? Whatever the answers, it shows what intriguing patterns data-crunching reveals.
It will also add to calls for more scrutiny of the Fed.
* “Stock Returns over the FOMC Cycle”, by Anna Cieslak, Duke University; Adair Morse, University of California, Berkeley, and National Bureau of Economic Research (NBER); and Annette Vissing-Jorgensen, University of California, Berkeley, NBER and the Centre for Economic and Policy Research