I came across a truly remarkable study this past week. I’m amazed that it has not provoked widespread commentary.
David Lucca and Emanuel Moench, economists at the New York Fed, make the case that from 1994 through the end of 2011 the effect of the Fed on the S&P 500 was huge. The Fed study demonstrated that nearly all the net gain in that stock index for more than 17 years came on the day of the Federal Open Market Committee (FOMC) announcements of Fed monetary policy decisions plus the one day immediately preceding and the one day immediately following those announcement days. Since there are but eight FOMC announcement days per year, the effect stems from a mere 24 market trading days each year.
The authors launched their study in 1994, when the Federal Reserve began announcing its target for the federal funds rate regularly around 2:15 PM on a pre-scheduled date. The authors show that, without the price movement in the three-day periods including the FOMC announcements from 1994 to 2011, the S&P 500 would have finished 2011 at about the 600 level. The actual S&P reading was above 1300.
Upon studying the graph included in the study, it appears that no appreciable variation existed until 1997, at which time the S&P 500 exceeded the 800 level. Over the ensuing 14 years, the S&P climbed above 1300 while the index without the FOMC days descended to 600. The vast bulk of the divergence occurred in the years after the stock market peak in 2000.
The Fed has bent every effort to support stocks in the years since the bubble near the turn of the century. They have openly acknowledged that campaign over the past few years.
The authors note that announced Fed monetary actions have not been the primary cause of the gains, because most of the gains have occurred in the hours before the actual FOMC announcements. It is unclear what has caused the gains. It could be that the investment community simply has great faith in the Fed’s ability to fine-tune the economy. Such trust, however, would not logically lead investors to concentrate their buying efforts in those three-day periods. It could also be another example of direct governmental interference in markets. Very possibly the government surmises that its best interests are served when investors retain a high degree of confidence in Fed actions.. To convey the impression of investor confidence, it may serve government’s interests to create an environment in which market gains appear to anticipate a wise Fed decision, followed by stability or further gains to validate that anticipatory strength.
I have long maintained that some government agency appears to be directly influencing stock market prices when it serves government’s needs. Many have scoffed at that assertion, but there is broad conviction that the “Plunge Protection Team” stands ready to provide sizable bids at important moments. Increasingly, the myth of free markets is crumbling. We know that the Fed now buys 70% or more of newly minted U.S. debt. We know that several foreign central banks have discussed their own direct equity purchases to support market prices. We know that our government bought bank, insurance and automobile stocks as part of the 2008-09 rescue effort. We know that governments around the world have been very willing to provide taxpayer money to cover the debt of important financial institutions. And we are now learning that our Fed and other government entities around the world knew several years ago that banks were falsifying LIBOR rates that affected hundreds of trillions of dollars in investments and mortgages. Don’t for a minute believe that our government won’t do whatever it deems necessary to serve its own interest relative to the equity markets.
I have not yet seen the entire New York Fed study documenting the critical three days around FOMC announcements. I expect there will be additional fodder for discussion after a more detailed analysis.
Click here to read the Lucca and Moench study: http://www.ritholtz.com/blog/2012/07/the-puzzling-pre-fomc-announcement-drift/