Remember all that talk about “the punch bowl” last year? The one that policy-makers were taking away? The upshot was that the party was over, and investors should brace for the mother of all hangovers.
It hasn’t exactly played out that way. The stock market, like the economy, has rebuffed the portents of doom. Both have displayed surprising resilience in the face of a determined effort to slow things down by the likes of the U.S. Federal Reserve and the Bank of Canada.
The S&P 500 index is up more than 20 per cent from the lows of last October. Canadian stocks have held up reasonably well also, notwithstanding a selloff in shares of the big banks.
The stock market tends to be highly sensitive to the direction and magnitude of central bank policy. So, what gives?
Well, even though the punch bowl is gone, the flow of punch was once so bounteous, that there is still a whole lot of it sloshing around.
“There are still lots of residual benefits from all the pandemic goodies that were handed out,” said David Stonehouse, head of North American and specialty investments at AGF Investments Inc.
“It will be interesting to see what happens when that excess has finally burned off.”
When the global pandemic struck in early 2020, the immediate blow to the U.S. and Canadian economies was in excess of 30 per cent, as measured by annualized GDP, from that year’s second quarter. The policy response was equally astronomical. One way of gauging that impact is to look at household savings.
By August, 2021, Americans had socked away an extra US$2.1-trillion beyond the prepandemic trend, according to estimates by the Federal Reserve Bank of San Francisco. A good chunk of that money ended up in financial markets, helping inflate a speculative stock bubble. Much of it was also plowed back into the economy, as robust consumer spending padded corporate profits.
It proved to be more money than U.S. households were capable of spending. About US$500-billion in excess savings remained as of the end of March, the San Francisco Fed said. That money could last into next year.
It’s a similar picture in Canada. Even as most pandemic support programs have ended, a great hoard of cash remains stuffed in Canadians’ bank accounts and money market funds. As of last year’s third quarter, excess savings stood at $340-billion, or “a massive 23 per cent of disposable income,” according to a BMO report from February.
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For those confused as to why a recession predicted with near unanimity last year has yet to materialize, excess savings goes a long way in providing an answer, Mr. Stonehouse said. It makes sense that there would be a long delay for all of that policy tightening to take effect, he added.
“We’re still trying to normalize and match up supply and demand as an economy.”
You could view how the stock market has fared the last year or so through a similar lens.
Granted, 2022 was a rotten one for investors, precipitated by the recognition that central banks would have to do everything in their power to conquer inflation. The S&P 500 dropped by as much as 25 per cent, while the drawdown in the S&P/TSX Composite Index peaked at 18 per cent.
Ever since, however, stock market sentiment has trended upward. The S&P 500 has made back two-thirds of what was lost in the selloff. In the 15 months since the Fed raised rates – the first salvo in total of five percentage points of hikes – the index is in positive territory.
Is that commensurate with the reversal of the great pandemic stimulus machine? And is that all that investors will have to endure as a result of one of the most aggressive rate-hike efforts on record? Unlikely.
It’s rare that the stock market breaks trend with the Fed, Craig Basinger, chief market strategist at Purpose Investments, wrote in a report. When it does happen, it’s usually the result of some momentous shock to the financial system. And even then, divergences tend to be short-lived.
“Any way you cut it, the stimulus is being drawn down, which is a headwind for equity prices,” Mr. Basinger said. In other words, there’s no party without a punch bowl.