Weighing the Impact of the Federal Reserve

July 17, 2020

This year, we’ve experienced the fastest bull-to-bear market 1 as well as the best 50-day performance on record.2 This has left many investors scratching their heads. Are price moves being influenced by fundamentals, or are there other factors at play?

In this piece, we’ll examine several variables that have impacted and continue to impact the market today.

During the market plunge in mid-March, equity prices were pushed down by a rising likelihood of recession and fear of the unknown.3 The drop was accelerated by many investors who were forced to sell assets they had bought using leverage, and by strategies that were selling stocks short and betting the decline would worsen.4 

While some of the decline was driven by fundamental concerns about the economy shutting and falling earnings, much of the decline was due to other factors. As a result, we saw a natural market snapback in the succeeding weeks as investors began to factor in a recovery and declining coronavirus cases across the globe.5


However, just as only part of the decline was due to fundamental factors, only part of the recovery has been supported by fundamentals. A non-fundamental facilitator in this bounce back has been the Federal Reserve that took swift and unprecedented action. The central bank took multiple measures to stabilize financial markets and the economy, including lowering interest rates, providing lending facilities and frantically purchasing securities.6


The old rule of “don’t fight the Fed”7 has certainly been true over the last several months. The good news is the Fed’s actions have supported markets and provided needed liquidity, and there will be ongoing additional asset purchases into the future.8 

  

However, there will also be aftereffects throughout markets for a long time. Interest rates are getting closer to zero, and we must pay significantly higher prices for bonds for the foreseeable future.9  That has driven some investors out of bonds and into higher risk securities to generate more return. Even some technology stocks that are seen as more immune to the downturn have begun to behave like bonds in daily trading.10


As investors, we’ll take the positive effects of Fed actions while we wait for more good news on fundamentals, such as the improving consumer spending in June.11 But we’ll also need to be watching for potential ill effects of Fed and government actions, such as rising inflation and greater leverage and indebtedness.

If you have any questions, please contact your advisor.

Sources:
1. Forbes (3/12/20) – The bear market is here! Fastest plunge of 20% on record
2. CNBC.com (6/3/20) – This is the greatest 50-day rally in the history of the S&P 500
3. CNBC.com (3/15/20) – If you’re panic shopping, chances are good you might also panic-sell your stocks
4. CNBC.com (3/22/20) – Breaking down this sell-off, among the most extreme and rare Wall Street has ever seen
5. Yahoo! Finance (3/24/20 – 5/12/20) – S&P 500
6. Brookings Institution (6/12/20) – What’s the Fed doing in response to the COVID-19 crisis? What more could it do?
7. The Balance (7/15/20) – What is don’t fight the Fed?
8. Financial Advisor Magazine (7/16/20) – Traders bet the Fed’s bond-buying binge has just begun
9. CNBC.com (6/10/20) – Fed sees interest rates staying near zero through 2022, GDP bouncing to 5% next year
10. CNBC.com (7/10/20) – Big Tech went from growth stocks to Wall Street’s Treasury bond substitute during the coronavirus
11. Forbes (7/16/20) – Consumer retail sales jump in June, fueled by car sales

The S&P 500® is widely regarded as the best single gauge of large-cap U.S. equities. There is over USD 9.9 trillion indexed or benchmarked to the index, with indexed assets comprising approximately USD 3.4 trillion of this total. The index includes 500 leading companies and covers approximately 80% of available market capitalization.

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