by Jeffrey Kleintop, Senior Vice President and Chief Global Investment Strategist, Charles Schwab & Co., Inc.
Key Points
- Central banks have often been credited with inflating the market through quantitative easing (QE) that inflated their balance sheets.
- Despite the coming shift by central banks towards trimming/tapering their balance sheets, we don't believe the bull market is at risk.
- Earnings, not easing, remain the key support for stock markets around the world.
Stock market investors have always kept an eye on the world's major central banks including the U.S. Federal Reserve (Fed), European Central Bank (ECB), and the Bank of Japan (BOJ), but since the financial crisis it has become almost an obsession. Central banks are often credited or blamed for the daily moves in the stock market as data is analyzed for how it may be interpreted by the world’s monetary policymakers. Even the longer-term trend in the stock market is often credited to central banks as seen in the chart below showing the growth in the Fed's balance sheet and the U.S. stock market since the financial crisis.
Was the bull market really driven by the Fed?
Source: Charles Schwab, Bloomberg data as of 9/17/2017.
Now that the Fed is set to trim its balance sheet for the first time, and the ECB is expected to taper their asset purchases next year, are stocks set to reverse all of their gains? We don't think so. While it appears the Fed's quantitative easing (QE) program that inflated their balance sheet also inflated the stock market, that association ended about a year ago as earnings lifted stock prices while the Fed’s balance sheet growth stalled. This divergence reveals that it is more likely to have been the rise in earnings, rather than Fed easing, that supported the rise in stocks.
We can see earnings, rather than easing, driving the stock market elsewhere, as well. For example, Japanese stocks and the growth in the BOJ’s balance sheet seem to look related, as you can see in the chart below.
Did the BOJ's balance sheet growth fuel Japan’s stock market?
Source: Charles Schwab, Bloomberg data as of 9/17/2017.
However, Japanese stocks have actually tracked growth in earnings per share even more closely than the BOJ balance sheet, as you can see in the chart below.
Or was it really earnings growth?
Source: Charles Schwab, Factset data as of 9/15/2017.
Turning to Europe, the link between the ECB's balance sheet and the stock market never appeared, as you can see in the chart below.
No relationship: the ECB balance sheet and Europe’s stock market
Source: Charles Schwab, Factset data as of 9/17/2017.
As you can see in the chart above, after growing the balance sheet in 2011 and 2012, the ECB trimmed in 2013 and 2014. Yet in 2013 and 2014 stocks in Europe rose along with earnings. This reveals that central banks are not the driver of the stock market and that since the financial crisis ended earnings growth is largely independent of central bank actions.
Global stocks continue to track earnings
Source: Charles Schwab, Factset data as of 9/17/2017.
The key takeaway is that we likely don't need to worry about the trim/taper of balance sheets by central banks or expect that Japan will be the best place to invest due to their ongoing balance sheet growth. The truth is easily revealed that the link between central bank balance sheets and the stock market is like the emperor's new clothes: there is nothing there.
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Important Disclosures
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.
Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.
The MSCI ACWI captures large and mid cap representation across 23 Developed Markets and 24 Emerging Markets countries. With 2,494 constituents, the index covers approximately 85% of the global investable equity opportunity set.
Standard and Poor's 500 Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The STOXX Europe 600 Index has a fixed number of 600 components and represents large, mid and small capitalization companies across 18 countries of the European region.
The Nikkei-225 Stock Average is a price-weighted average of 225 top-rated Japanese companies listed in the First Section of the Tokyo Stock Exchange.
The MSCI Japan Index is designed to measure the performance of the large and mid cap segments of the Japanese market. With 320 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in Japan.
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