Many investors are anxiously waiting to see who wins the upcoming presidential election, as they believe that the outcome will have a marked effect on the stock market. Meanwhile, according to a recently reported study, it appears that one factor that does have a noticeable effect is monetary policy. In other words, what Alan Greenspan and friends do to interest rates may have a bigger effect on the market than George Bush's or John Kerry's election.
In a June 2004 study covering a period of 38 years, the CFA Institute, Northern Illinois University, The University of Richmond, and Texas Tech University found "a strong connection between U.S. monetary policy and global stock market returns." Specifically, during periods when U.S. monetary policy is "restrictive" and interest rates are rising, the overall stock market tends to falter, offering lower-than-average returns and higher-than-average risk. (And vice versa.)
Here are some more findings:
- ".Stocks averaged returns of 21.86% during periods of expansive monetary policy versus just 2.84% when Fed policy on interest rates was restrictive. While initial analysis suggests that the relationship between the two has lessened throughout the years, the results are nonetheless consistent across policy periods save for a single monetary period in the mid-1990s that coincided with the tech boom."
- ".Small-cap companies and those in cyclical markets are particularly sensitive to changes in monetary policy. In fact, companies in sectors such as cyclical services, information technology and cyclical consumer goods such as automotive, media and hotel, restaurant and leisure industries performed 26% better during periods of expansive monetary policy. The effects of policy changes were least pronounced for sectors such as utilities and non-cyclical consumer goods such as food and drug retailers and food, beverage and tobacco companies." (This suggests that some stocks worth investigating might include Procter & Gamble
(NYSE:PG), Pfizer (NYSE:PFE), and Anheuser-Busch (NYSE:BUD).)
- Perhaps not surprisingly, American economic policy also affects global stock markets to a significant degree.
What does this mean for us? Well, with interest rates still very much near the low end of the historic range, even after the Fed hiked the Fed funds rate from 1.50% to 1.75% last week, it's more likely that rates will rise than fall in the coming years. The study cited doesn't have perfect vision and can't guarantee results, but it's a good wake-up call, nevertheless. Make sure that you're prepared for a period of sluggish market performance. Make sure you can tolerate always-possible low returns and increased risk. If you can't, perhaps stock market investing isn't for you, or maybe you just need to move a portion of your investments into "safer" alternatives. Learn about your short-term savings options in our Savings Center, for starters -- it offers some special interest rates for Fools.
Longtime Fool contributor Selena Maranjian owns shares of Pfizer.