A new research paper that analyzes the timing of stock market booms around the world in the 20th century in relation to macroeconomic conditions probably won’t surprise enlightened observers of the money game. But what the paper lacks in shocking disclosures it makes up with a timely reminder that equity bull markets tend to thrive under a particular set of conditions. Conditions, some argue, that appear to be on the wane these days.
Indeed, a new working paper published on the St. Louis Fed’s web site, When Do Stock Market Booms Occur? The Macroeconomic and Policy Environments of 20th Century Booms delivers fresh reason to wonder if the current run in stocks still has legs. “We find that booms generally occurred during periods of above-average economic growth and below-average inflation, and that booms typically ended when monetary policy tightened in response to rising inflation,” write authors Michael Bordo (an economics professor at Rutgers) and David Wheelock (an economist at the St. Louis Fed). “Most booms were procyclical, arising during business cycle recoveries and expansions, and ending when rising inflation and tighter monetary policy were followed by declining economic activity.”
How does that trend relate to the outlook for stocks in 2006? Or, perhaps we should ask, does it relate at all? Before we can even take a shot at an answer, there’s the awkward problem of deciding if the economy is currently winding down, heading up or set for an extended period of treading water. Alas, the jury is out on this one–way, way out, to judge by the degree of uncertainty that permeates the economic news of late.
To be sure, a considerable downshift in economic growth has been recorded in the second quarter relative to the first. Meanwhile, there’s any number of reasons to think that the slowdown is more than temporary, including the widely publicized slippage in the housing market. But the optimists aren’t giving up just yet.
The latest catalyst for thinking that the old bull isn’t dead yet comes by watching the decline in oil prices. A barrel of crude is priced under $64 in New York trading, the lowest since March, and down by more than $10 since early August. Hardly a bargain by the standards of the past decade, but the direction at least is expected to cheer the consuming masses.
Today’s Wall Street Journal ran a story that explores the potential for a fresh burst of consumer spending fueled by the recent drop in energy prices. Although some dismiss the idea outright, others still find reason to think that a second wind is possible in the current cycle. Robert Mellman, senior economist at J.P. Morgan Chase, is one dismal scientist who thinks that Joe Sixpack may find inspiration anew for pulling out his credit card down at the local mall. Lower gasoline prices could raise the annual pace of consumer spending a full percentage point, he told the Journal. In turn, the annualized fourth-quarter economic growth would jump to 3.7% from an expected 3.0%.
Of course, oil and gasoline prices need to stay down for more than a few weeks to deliver tangible results. We’ll see.
Meanwhile, Bordo and Wheelock’s research raises some provocative questions at a time when inflation, while still relatively low, has ticked up. Stock market booms, the authors write, “typically arose when inflation was low and declining, and ended within a few months of an increase in the rate of inflation. Rising inflation tended to bring tighter monetary conditions, reflected in higher real interest rates, declining term spreads, and reduced money stock growth.”
Among the many questions weighing on Mr. Market comes one more that’s inspired from Bordo and Wheelock’s research, namely: Does the paper’s observation of the past inform investors about what comes next?