Do you know what drives stock prices in this bull market?
If you said monetary policy from the Federal Reserve Bank, corporate earnings and the monthly jobs reports you would be spot on. Before I lose you with a discussion of monetary policy, let me suggest you get a copy of my book, Figuring Out Wall Street. It includes chapters on the role of the federal reserve and the role of economic indicators in driving stock prices. Corporate earnings are also explained in the book.
Right now the monetary policy of the Fed is to buy bonds, under a program called QEe or quantitative easing. Recently the Federal Reserve announced the policy may change in the future, but for now every month the Federal Reserve buys ups bonds in order to keep interest rates low. Specifically it buys mortgage-backed securities to stimulate home buying, new construction and, it is hoped, stimulate the economic recovery. Quantitative easing increases reserves at banks, and raises the prices of the financial assets bought, which lowers the yield. Right now banks are holding over two trillion dollars in excess reserves in their accounts at the Federal Reserve, earning just .25% interest.
We have all seen how the stock markets reacts when the initial claims for unemployment benefits is reported. As new claims go down, stocks continue to rise. Just take a look at the chart below, comparing the S&P 500 index to weekly unemployment claims. Fortunately this trend has been positive since the economic recovery started back in March of 2009. Not really strong numbers, but this is a very strong correlation.
The third driver for the stock markets is Wall Street's consensus estimate for earnings per share for the S&P 500 Index. Now this shouldn’t be a surprise to anyone, stock prices always follow earnings (or bad news, in the case of price declines).
Another earnings reporting season started this week, with aluminum giant, Alcoa (AA), reporting Monday evening that beat expectations. Now the collective wisdom of Wall Street analysts is that corporate earnings of S&P 500 companies will be less than one percent growth. If they are right, the stock market will slip lower for the rest of the summer, if they are wrong look for this bull market to continue.