Here’s a chart we’ve probably run about 100 times.
It shows the S&P 500 (blue) vs. the inverse of initial claims (red) going back about 5.5 years.
As you can see, the two lines have moved very closely together. The point is not that initial claims are all that matters, but the correlation does suggest that what’s really driving the market are the real fundamentals of the economy.
It also suggests that other stuff like Europe headlines and Fed chatter are less important for the stock market than they’re generally given credit for.
The latter point, the impact of the Fed on markets, has been a source of tons of controversy and attention, as anyone who turns on CNBC for 5 minutes is well aware of.
So if it can be established that the Fed isn’t really itself a huge driver of the market, then this would be a significant breakthrough on what’s making the market tick.
Unfortunately, the above chart doesn’t quite resolve the question.
Here’s why. If we narrow the range of the chart to just 2010, this is what we see.
For the most part the lines match up pretty well. Initial claims and the stock market improved in the beginning of the year. Then initial claims and stocks weakened in the middle of the year, and then both improved solidly starting at the end of the summer.
But here’s the problem. QE2 was also launched at the end of summer 2010, so some people might say: The stock market rose due to the economy improving, while others will say: the stock market only rose because right at the same time, the Fed began its infamous asset purchase program.
There is another possibility, which is that the Fed itself, by doing more easing, caused initial claims to improve at the end of summer 2010, meaning all three are inter-connected.
We run into the same problem in 2011.
In this year, the connection in claims and the stock market isn’t quite as pretty, but a lot of that has to do with the fact that stocks crashed in the aftermath of the debt downgrade and the debt ceiling fight. The economy never really deteriorated to match the event-driven freakout in stock prices. But even still, you can see that in the final three months of the year, there was a nice gain in stock prices (blue line), and nice improvement in initial claims (red).
And yet here again we have a problem! That’s because on September 21, 2011, the Fed announced Operation Twist (which is essentially QE3) so once again, it becomes hard to figure out, timing-wise, whether the rebound in the stock market is related to Fed action or the improvement in jobless claims.
So where does that leave us now?
Let’s go to the same chart year-to-date in 2012.
The chart is obviously noisy, but it’s actually pretty nice. The stock market improved nicely through the first third of the year, and initial claims did too. Then both dipped into the summer. And now both are improving.
But finally we have our “control” year that’s different from 2010 or 2011 because expectations of QE have been collapsing.
First of all, the Fed’s last two meetings have clearly been more hawkish than people expected. There’s been virtually no new action, and even the language hasn’t been as dovish as some have predicted.
Today, Goldman’s Jan Hatzius threw in the towel, and said there would be no more QE this year.
Bank of America did the same, citing yesterday’s strong retail sales report.
In a note out last night, BTIG’s Dan Greenhaus included the following read on investor concerns:
…we’re starting to get questioned as to whether “investors are rallying themselves out of a QE3” and what effect this might have on the Chairman at Jackson Hole.
So buy-side investors think QE might be off the table, and Wall Street economists no longer expect more easing to happen this year.
And yet! Markets are rising along with improving fundamentals.
We’re getting a real-time lesson: Improvements in the economy translate into improvements in the market. The obsession with QE, and whether bad data is good because it might cause the Fed to ease more, is mostly a noisy distraction.
SEE ALSO: Why Goldman Sachs no longer expects QE >