Government stimulus drove most gains of past 10 years

You’ve probably seen this chart showing the striking relastionship of the S&P 500’s gains in the past decade to Federal Reserve stimulus phases 1, 2, and 3. But perhaps you’ve wondered if that’s just a coincidence.

Well, the fourth quarter of 2018 made clear it’s no coincidence.

2019 S&P 500 vs stocks.gif

We’ve marked periods on the chart as easing, pause, and tightening. Then we graphed these periods by average S&P 500 weekly return in the period vs weekly Fed stimulus in that same period, and ran a regression.

2019 returns vs Fed stimulus.gif

The result is that ~93% of the S&P 500’s gain over the past 10 years can be attributed to Federal Reserve stimulus. Data scientists call this a slam dunk sort of relationship. Rarely is such correlation between such cause and effect found in the real world.

Now that the Federal Reserve is unwinding its balance sheet and looking to continue raising interest rates, what does this mean? More stock market volatility to come, for sure.


U.S. equity market quiescent

During the second quarter of 2015, our market stress indicator remained consistently in the offensive portfolio state.  All U.S. equity indices traded within a historically narrow range and ended the quarter essentially flat.  In fact, the narrow S&P 500 range in the first six months of 2015 placed the period in the lowest decile of all 6-month periods ranked by trading range going back to 1953.  Such a narrow range is rare, but not predictive of future returns.  In the middle 1990s the S&P 500 broke out of its narrow range to resume the strong bull market trend of that decade, but in 2007 the range breakout occurred to the downside with the global financial crisis.  What is clear is that periods of such low volatility are anomalous and not representative of the normal state of the equity market.