All eyes are on the Federal Reserve this week as they convene their latest Open Market Committee meeting on Tuesday and Wednesday to discuss monetary policy. A primary focus of investors is whether the Fed will hint about any future policy action.
Such news is important, as the stock market has proven keenly sensitive to the influences of monetary stimulus since the outbreak of the financial crisis several years ago. But while another round of policy support may help stabilize the stock market at current levels, Fed stimulus alone may no longer be enough to drive stocks to new highs. Moreover, it may now be insufficient to offset the forces of a major downside shock.
A reflection on the movements of the stock market since October 2011 is informative in this regard. The U.S. stock market as measured by the S&P 500 Index (SPY) initially exploded higher at the launch of Operation Twist. Having touched a fresh cycle low at 1075, the stock market suddenly reversed and didn't look back for the entire month. From the second day to the second to last day of October, the stock market advanced roughly +17%. But what is surprising is that since the end of October, the net impact of Operation Twist by itself has actually been fading lower from its peak.
The first sign of breakability associated with Operation Twist came on Halloween, as the market became spooked by the collapse of MF Global. By Thanksgiving, the U.S. stock market had bled nearly -10% and was only +5% above the early October lows. The market response to the MF Global bankruptcy was notable, for stocks prior that point had shown the resilience to continue rising during periods of Fed stimulus regardless of the risk. Such was not the case in November 2011.
Stocks thrashed back and forth into December until the week before Christmas. It was at this point on December 21 that the European Central Bank executed the first of its two planned Long-Term Refinancing Operations (LTRO) to support the at risk banking system across the continent.
It was upon the launch of LTRO that the stock market propelled itself into another euphoric melt up phase. This continued until the second planned LTRO on February 29. Along the way, the stock market advanced +14% in a virtually uninterrupted rally that included stocks rising on nearly 70% of trading days over this time period. This is well above the historical average of 52% and is exceptionally rare to occur over any sustained period of market history.
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