This summer’s stock market rally has had an unusual driver: Bad news.
The global economy is weakening, corporate profits have been struggling to match forecasts and Europe’s sovereign-debt crisis lingers on.
But in the upside-down world of investing, gloomy conditions are feeding expectations that the world’s most important central banks are about to take action with a powerful round of economic stimulus – sooner rather than later.
Any new policy initiatives would face skepticism from critics who doubt their ability to get people back to work, but they would be an important indicator that central bankers are not content to let their economies muddle along the current path of slow growth and high unemployment.
U.S. Federal Reserve chairman Ben Bernanke could give an indication of his intentions as early as Friday, when he delivers a speech at Jackson Hole, Wyo., to a gathering of the world’s top economists.
“It’s not that the [U.S.] economy is headed for a recession. It’s more that growth isn’t sufficiently rapid enough to drive down the unemployment rate,” said Paul Ashworth, chief North American economist at Capital Economics.
A co-ordinated global response is emerging as a possibility. The European Central Bank is widely believed to be on the verge of launching a program in which it would buy massive amounts of Spanish and Italian bonds. And the People’s Bank of China could simply cut its key interest rate to give China’s slowing economy a boost.
The question is whether another round of stimulus will have much impact – particularly in the United States.
“There have already been three meaningful attempts by the Fed to kick-start the expansion,” said Sal Guatieri, senior economist at BMO Nesbitt Burns. “At best, those attempts have just kept the economy growing at a subdued clip.”
So far, that has been good enough for stocks. Major indexes have delivered impressive gains this summer, a season that is usually associated with market doldrums.
Since the beginning of June, the S&P 500 has rebounded 10.4 per cent, touching a four-year high this week, while Germany’s DAX index has risen 17 per cent. Canada’s benchmark index has lagged, but nonetheless has risen 6.6 per cent.
To be sure, these gains have coincided with upbeat news on U.S. housing, better-than-expected job gains in July and new urgency among European policy makers in addressing the debt crisis.
But against a backdrop of low growth and high unemployment, the possibility of central bank stimulus has been a key factor driving stocks higher.
The market’s recovery on Friday underlined the importance of stimulus hopes. The S&P 500 declined after a disappointing report on durable goods orders but rebounded after the publication of a recent letter from Mr. Bernanke to a key Congressman.
Investors took the start of the letter – “There is scope for further action by Federal Reserve to ease financial conditions and strengthen the recovery” – as a push for more stimulus.
This summer’s surge suggests the stock market has already factored in expectations for central bank action. That could make for a wild ride if investors are disappointed.
Either way, it underlines how the market has come to rely upon assistance from policy makers. “It’s incredible that the market needs such hand-holding from the Fed,” said David Rosenberg, chief economist and strategist at Gluskin Sheff + Associates, in a note.
The Fed has held its key interest rate at zero per cent and promised to keep it there through late 2014. And it has spent $2-trillion (U.S.) in bond-buying programs to drive down borrowing costs.
“And what are we left with?” Mr. Rosenberg asks. “A stock market that swings around like a yo-yo and is still no higher today than it was 12 years ago, and the weakest pace of economic growth ever recorded for three years of post-recession activity.”
Stock prices aside, there are questions about what further action can do to help the weak global economy, beyond nudging already-low interest rates a little lower.
“I don’t expect it to have any dramatic impact on anything, to be honest,” Capital Economics’ Mr. Ashworth said.