How the Shift by Central Banks May Affect the Stock Market

Article provided by Jeffrey Kleintop, Senior Vice President, Chief Global Investment Strategist at Charles Schwab who provides research, commentary and actionable insights to Schwab’s client-facing teams and the firm’s Investor and Advisor Services.

Stock market investors have always kept an eye on the world’s major central banks including the U.S. Federal Reserve (Fed), European Central Bank (ECB), and the Bank of Japan (BOJ), but since the financial crisis it has become almost an obsession. Central banks are often credited or blamed for the daily moves in the stock market as data is analyzed for how it may be interpreted by the world’s monetary policymakers. Even the longer-term trend in the stock market is often credited to central banks as seen in the chart below showing the growth in the Fed’s balance sheet and the U.S. stock market since the financial crisis.

Was the bull market really driven by the Fed?

S&P 500 and Fed Balance Sheet

Source: Charles Schwab, Bloomberg data as of 9/17/2017.

Now that the Fed is set to trim its balance sheet for the first time, and the ECB is expected to taper their asset purchases next year, are stocks set to reverse all of their gains? We don’t think so. While it appears the Fed’s quantitative easing (QE) program that inflated their balance sheet also inflated the stock market, that association ended about a year ago as earnings lifted stock prices while the Fed’s balance sheet growth stalled. This divergence reveals that it is more likely to have been the rise in earnings, rather than Fed easing, that supported the rise in stocks.

We can see earnings, rather than easing, driving the stock market elsewhere, as well. For example, Japanese stocks and the growth in the BOJ’s balance sheet seem to look related, as you can see in the chart below.

Did the BOJ’s balance sheet growth fuel Japan’s stock market?

Nikkei BoJ Assets

Source: Charles Schwab, Bloomberg data as of 9/17/2017.

However, Japanese stocks have actually tracked growth in earnings per share even more closely than the BOJ balance sheet, as you can see in the chart below.

Or was it really earnings growth?


Source: Charles Schwab, Factset data as of 9/15/2017.

Turning to Europe, the link between the ECB’s balance sheet and the stock market never appeared, as you can see in the chart below.

No relationship: the ECB balance sheet and Europe’s stock market

Europ Stoxx 600 ECB Balance Sheet

Source: Charles Schwab, Factset data as of 9/17/2017.

As you can see in the chart above, after growing the balance sheet in 2011 and 2012, the ECB trimmed in 2013 and 2014. Yet in 2013 and 2014 stocks in Europe rose along with earnings. This reveals that central banks are not the driver of the stock market and that since the financial crisis ended earnings growth is largely independent of central bank actions.

Global stocks continue to track earnings

MSCI AC All World and Consensus EPS

Source: Charles Schwab, Factset data as of 9/17/2017.

The key takeaway is that we likely don’t need to worry about the trim/taper of balance sheets by central banks or expect that Japan will be the best place to invest due to their ongoing balance sheet growth. The truth is easily revealed that the link between central bank balance sheets and the stock market is like the emperor’s new clothes: there is nothing there.


Key Points
  • Central banks have often been credited with inflating the market through quantitative easing (QE) that inflated their balance sheets.
  • Despite the coming shift by central banks towards trimming/tapering their balance sheets, we don’t believe the bull market is at risk.
  • Earnings, not easing, remain the key support for stock markets around the world.

Important Disclosures


The opinions expressed in post are those of the author and not necessarily the same as those of Aquinas Capital Advisors LLC. Aquinas Capital Advisors LLC did notassist in the preparation of the material and makes no guarantee as to its accuracy or the reliability of the sources used for its preparation.

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