Is the Fed Responsible for the Stock Market Rise Since 2009?

The phrase “this time is different” is often associated with a misunderstanding of the past and an unwillingness to accept time tested facts. Most often this phrase is uttered at stock market tops as an indication that basic rules of economics no longer apply. Unfortunately, there is a back door reference to “this time being different” when market analysts, of the bearish perspective, make claims that this “exceptional” market run is being fueled by the Federal Reserve Bank.

The thought is that, with all the printing of money and “quantitative easing”, the only reason that the market could possibly rise as much as it has (only +123% from the March 9, 2009 low) is because of the Federal Reserve. In this piece, we’re going to show that Fed or not, the market, after a large decline of -40% or more, retracing +50% to +100% of the prior losses is typical market behavior.

To best demonstrate our point, we’re going to start by examining the stock market at a time when there wasn’t a central bank in the U.S. from 1836 to 1914.  After all, if there wasn’t a central bank to “control” the economy then the stock market should have acted in a “certain” fashion.

The Second Bank of the United States charter ended January 1836 and was not allowed to be renewed.  However, it is important to point out that the index of leading railroad stocks had already peaked in 1835 at the level of 42 and was already in an established downtrend.  By 1842, the railroad stock index had declined to 11, or a loss of -73%.  From the low at 11 in 1842, the railroad index increased to 37 by the end of 1852, this was an increase of +236% and a recovery of +83% in the prior decline.

From the peak of rail stocks in late 1852 at the 37 level, a decline to the 13 level by mid-1857 resulted in a loss of -64%. However, the subsequent rise from the 1857 low at 13 was followed by the rail index peaking at the 50 level by 1864, a gain of +284%.

The subsequent decline from the 50 level in 1864 to as low as 21 incurred a loss of -58% by 1877. The following rise, from 21 in 1877 to the level of 62 in 1881 was an increase of over +195%.

After the 1881 peak in the ten leading stocks at the 62 level, the stock average promptly dropped to the 45 level in 1885, a loss of over -27%. However, the rise in stocks from the bottom in 1884 took the index to 127 in 1902, or an increase of +182%.

The peak of 1902 at 127 was quickly followed by a decline of the leading rail stocks to 90 by 1903, a decline of -29%.  From the 1903 low of 90, the index of rail stocks peaked in 1906 at 137 for a gain of +52%.  After the peak in 1906, the index declined -37% to the low in 1907.  From the low in 1907, the index climbed to the 130 level in 1909 for a gain of +52%.  After the 1909 peak, the index declined -46% to the 69 level in 1921.  As we all know, the subsequent peak in 1929 was at the 189 level for a gain of +169%.

The most important concept that should be taken away from all this data is that a central bank did not exist from 1836-1914. There was no way to ascribe the gains of the market to the Federal Reserve. All iterations of a central bank with the First Bank of the United States (1791-1811) and the Second Bank of the United States (1816-1836) did not have any effect on the data sets that we have provided from the period of 1836 to 1914. In order for the claim that the current market run is based on the monetary policies of the Federal Reserve, we’d need to be able to demonstrate that the stock market would have behaved differently without the existence of a Federal Reserve.

Unfortunately, those that claim “this time is different”, as in the Fed is manipulating the market higher, aren’t trying hard enough to prove their claim false. A cursory review of market data during the periods from 1836 to 1914 makes it clear that declines of nearly -40% or more are likely to retrace +66% to +100%, if not more. This pattern has been easily demonstrated in the periods after January 1914 when the current Federal Reserve system started operations. However, we’ve taken our claim about market declines and have extended it to periods when there wasn’t a central bank to show that the Federal Reserve’s role as the leading cause of the current +121% retracement of the prior decline (2007-2009) is false.

Finally, if the Dow Jones Industrial Average were to increase at the average of the gains indicated above (+236%, +284%, +195%, +182%, +52%, +52, +169%), the index would increase to 17,500 level (+167%).

Note: The above piece is an updated article that was originally posted in 2011 with the data and charts to support our latest revision (original article found here).  The difference between this posting and the one done in 2011 is that all the data is drawn from a single and separate source.  This distinction is significant since it reflects that multiple sources demonstrate similar information about how the stock market performed even when a Central Bank didn’t exist.

See Also:

• Are the S&P 500 and the Dow Exactly the Same?

Source:

• Arthur H. Cole and Edwin Frickey. “The Course of Stock Prices, 1825-66”. The Review of Economics and Statistics. Vol. 10, No. 3, August 1928. page 117-139.
• data and article retrieval from JSTOR. www.jstor.org