Do we have the Federal Reserve to thank for the recent stock rally? The only logical answer is yes, according to TrimTabs, a research firm that tracks money flows in and out of the stock market. As I read the title of their report, I thought it might be a mad-hatter conspiracy theory, but the analysis is rather compelling. If they are correct, it could have significant implications for the longevity of the powerful rally that lifted the market from its March lows last year.
Following the cash
Here's the line of reasoning: U.S. stocks gained $6 trillion in aggregate market value starting in mid-March. According to TrimTabs, historically, increases in stock market value require a net cash inflow into stocks equivalent to 10% of the increase, or $600 billion in this instance. However, the firm couldn't trace the origins of anything close to that sum from among traditional market participants. The following table summarizes TrimTabs' findings:
|
Investor Type |
Buying Stock During the Rally? |
TrimTabs' Comments |
|---|---|---|
|
Companies |
No |
Net sellers of stock (share issues). |
|
Individual Investors (Retail Stock Funds) |
No (Insignificant) |
Net inflows to U.S. equity funds and ETFs total just $17 billion since the beginning of April. |
|
Individual Investors (Direct Purchases) |
No |
High market volatility and neutral individual investor sentiment argue against significant purchases. |
|
Foreign Investors |
Yes |
Foreign investors purchased $109 billion worth of U.S. stocks from April through October. |
|
Pension Funds |
Yes |
Anecdotal evidence suggests pension funds have moved no more than $100 billion into stocks since the rally began. |
|
Hedge Funds |
Unsure |
Probably not in significant amounts as hedge funds suffered net outflows of $12 billion between April and November. |
Source: TrimTabs.
If TrimTabs is right, we're far short of the $600 billion needed to fuel the rally we witnessed. But would a central bank intervene directly in its equity markets? Although unorthodox, this has occurred (at least) three times -- in two advanced economies, no less -- since 1998.
Hong Kong shuffle
During the 1998 Asian currency crisis, the Hong Kong Monetary Authority (HKMA) purchased US$15.1 billion worth of Hong Kong shares -- approximately 6% of the value of the entire market -- to stabilize markets. At the time, the U.S. Treasury and then-Fed chief Alan Greenspan roundly criticized Hong Kong's action. The Hong Kong government ultimately bundled the shares into an index fund that they sold to the public in the course of realizing US$14 billion in profits.
Last year, starting on Feb. 23, the Bank of Japan (BOJ) purchased 207 billion yen (approximately billion $2.2 billion) in bank-held shares, with a target investment of 1 trillion yen. Between 2002 and 2004, the BOJ also bought stocks as part of a 3 trillion yen-buying program, which it started to unwind in 2007 -- shares sales were halted a year later as Lehman Brothers collapsed.
Going "all in" on bank stocks
Comparing the two, the BOJ's intervention looks like the better model for a hypothetical Fed action. I'd be more inclined to believe that the Fed implemented a smaller, more focused operation consisting in buying bank shares on the open market to complement its TARP investments. Last March, with all eyes on the banking sector and bank stocks suffering devastating losses, the Fed could have reasoned that a turnaround in bank stock prices would have a significant positive impact on market sentiment.
In aggregate, U.S. financials gained $1.3 trillion in market value from the March 9 market low through the end of 2009 (see table below). According to TrimTabs' "10%" rule of thumb, that increase would have necessitated just $130 billion of new cash invested in the sector -- a trifling sum in this era of trillion-dollar bailouts.
|
Financial |
Increase in Market Value Between 03/09/2009 and 12/31/2009 |
|---|---|
|
JPMorgan Chase |
$111.3 billion |
|
Bank of America |
$106.3 billion |
|
Wells Fargo |
$95.7 billion |
|
Citigroup |
$69.9 billion |
|
Goldman Sachs |
$52.7 billion |
|
Berkshire Hathaway |
$40.2 billion |
|
Total -- Entire Financial Sector |
$1.3 trillion |
Source: Author's calculations, based on data from Capital IQ, a division of Standard & Poor's.
Regardless of where the cash came from, one thing is certain: Financials led the rally. From its low, the S&P 500 rose 65% in 2009; the KBW Bank index eclipsed that performance with a 118% gain.
Ultimately, though, this is all just conjecture. I think the likelihood of a Fed share buying campaign is very low, and here's why: Both the Hong Kong and Japanese central banks publicly announced their plans to buy equities; if the Fed has intervened in the stock market, it has done so in total secrecy. At a time when the central bank is already facing unprecedented backlash concerning its role leading up to and during the crisis, this would surely amount to political suicide if it were to surface. I don't think it happened -- but I can't rule it out entirely.
Conjecture is fleeting, tangible risks remain
Either way, I've warned Fool readers repeatedly about the risks of owning low-quality, speculative financial shares, most prominent among which are three companies that are on official government life support: AIG
The Fed's policies are creating a new set of tangible risks for investors. Motley Fool Global Gains co-advisor Tim Hanson explains why it's time to get out now.
