September is historically the worst month of the year for the stock markets. Since 1950, the Dow Jones Industrial Average has lost 1.1 percent in an average September. The S&P 500 averages a 0.7 percent decline, and the tech-heavy Nasdaq typically loses about 1 percent for the month.
So why was the Dow up last month—albeit by a modest 0.4 percent—especially in the face of bad economic news? Are some years just better than others? Or was this rise just the lag-end of a recovery from the crash of March 2009, when the Dow hit a low point of 6627?
Increasingly, analysts suggest that government decisions and not business fundamentals drive the performance of the stock markets—especially large-cap stocks represented by the major exchanges. Among these factors: inflation, as investors bet that government debt will devalue the dollar and drive up the nominal cost of assets.
Consider, for example, Fed Chairman Ben Bernanke’s announcement of Quantitative Easing 3 (QE3) on Sept. 13. The open-ended plan to buy $40 billion per month in mortgage-backed securities sent the Dow up more than 200 points, to a five-year high, the next day. But many analysts said the market soared not because stocks were suddenly worth more, but because the U.S. dollar will be worth less in the future, since the only way the Fed can buy these bonds is to increase the money supply, popularly (and accurately) known as “printing more money.”
All of this is why Robert Brusca, president of Fact and Opinion Economics, said, “It makes me wary that the Fed may be targeting a reaction in the stock market.” It’s a fair suspicion. Big moves in the U.S. exchanges often move the global markets. A 200-point, or 1.5 percent, rise in the Dow, if it’s followed by the other major markets, can generate a $500 billion increase in global market capitalization—in a single day.
When markets are up, people and corporations feel richer and are more likely to spend. That has a real—not artificial—impact on the economy. So far, though, corporations have been as wary as Brusca. By some estimates, U.S. companies have as much as $3 trillion in cash or cash-equivalent assets on their balance sheets. It’s an amount that, if lured off the sidelines, would dwarf any government stimulus plan. But corporate executives share Brusca’s fear: “When the Fed artificially moves the markets, at some point the markets will undo the move,” possibly precipitously. If that happens, corporations want enough cash on hand to weather the storm.
Even so, Bernanke’s move could work, depending on your definition of “work.” By announcing an ongoing, open-ended, $40 billion a month purchase of bonds, plus the promise of low interest rates through the end of 2014, Bernanke created predictability, which markets like, and that may have cheated the “September Curse” in the markets.
Nonetheless, Robert Fisher, president of the Federal Reserve Bank of Dallas, strongly opposed the move. He said, “Nobody sees an immediate threat of inflation,” and that takes some of the political pressure off of this decision. But Fisher thinks inflation after 2014 is likely. “We’re going to have to monitor this very closely,” he said.
Till then, some corporations may make the purely rational decision to stop hanging on to cash, which inflation will make less valuable over time, and make investments that could result in increases in their non-cash assets, and in increased economic activity.
At least that’s Bernanke’s bet. But he is playing a dangerous game of chicken with inflation. He may already be losing. The current annual inflation rate is about 1.7 percent. An obscure measure, the “five-year, five-year forward breakeven rate,” projects inflation five years in the future. That measure rose to 2.88 percent on Sept. 14—the day after the Fed Open Markets Committee announced the bond buying program.