Has the Fed's Stimulus Created a Stock Market Bubble?

new york stock exchange trading floor federal reserve bond buying program
Richard Drew/AP
By CHRISTOPHER S. RUGABER

WASHINGTON -- A nervous debate is raging among investors and analysts: Has the Federal Reserve inflated a stock market bubble by driving interest rates to record lows?

The answer, according to economists surveyed by The Associated Press: No.

Three-quarters of the economists say stocks, which are at their lowest point in a month but are up 19 percent since November, aren't overvalued. Many point to strong corporate profits as justifying the surge in stock prices, which have more than doubled since bottoming in 2009.

The economists expect many consumers to respond to their increased stock wealth by spending more in coming months. Higher spending would help sustain and perhaps accelerate growth.


The economists think growth is slowing to around a 2 percent annual rate in the April-June quarter from a 2.4 percent rate last quarter. The key reasons: Federal spending cuts, higher taxes and economic weakness in Europe and elsewhere.

But they say U.S. economic growth should increase in the second half of this year and speed up next year. Besides the stock market gains, steady job growth and surging home prices will likely fuel more spending.

They forecast that growth will reach 2.8 percent in 2014 as hiring accelerates and consumer confidence -- now at a five-year high -- improves further. If they're accurate, that would be the fastest growth since 2005.

"A bubble is an extreme thing, when the market loses all contact with reality," says Bill Cheney, chief economist at John Hancock Financial Services. "I don't think we're near anything like that."

Most of the nearly three dozen economists surveyed by the AP say the Fed's policies have helped boost stock prices. The Fed has been buying $85 billion in bonds each month to try to keep loan costs at record lows and encourage borrowing and spending. The super-low rates have led some investors to shift money out of low-yielding bonds and savings accounts and into stocks, thereby boosting stock prices.

In recent weeks, stock and bond investors have been rattled by speculation that the Fed will start to scale back its bond purchases later this year. Once it does, interest rates would likely creep up. Some investors could sell stocks and buy higher-yielding bonds. Stock prices could fall.

For now, broad measures of stock prices remain in line with historic norms, given the strength of company profits, the economists say. The Standard & Poor's 500 stock index (^GSPC), relative to expected corporate earnings, is only about half its level of late 1999. That was a few months before the dot-com frenzy fizzled and punctured a stock-market bubble.

Jerry Webman, chief economist at OppenheimerFunds, notes that in most bubbles, stocks or other assets are significantly overvalued. Investors typically invent reasons to explain that fact away.

In the late 1990s, for example, "We were talking about 'the new economy,' 'this is all different now' and so on."

But "people aren't saying that about stocks now," Webman says.

The AP survey collected the views of private, corporate and academic economists on a range of issues. Among their views:
  • Housing will deliver the biggest boost to the U.S. economy this year -- more than will higher stock prices or the Fed's low-rate policies. Higher home values and sales and increased construction have helped restore household wealth, generated jobs, boosted spending on home furnishings and other goods and services and strengthened banks as mortgage defaults have declined. It's also a big reason pickup truck sales have jumped: Busier contractors and landscapers buy more trucks.
  • U.S. consumers will step up spending once the job market returns to full health, though not as much as before the Great Recession. In the 10 years through 2007, consumer spending, adjusted for inflation, grew at an average annual rate of 3.6 percent. Since the recession ended in 2009, it's grown at an average rate of just 2 percent. The job market would be considered healthy when unemployment falls between 5 percent and 6 percent. It's now 7.5 percent. On Friday, the government will issue the May jobs report. Employers are expected to have added 170,000 jobs. No change is expected in the unemployment rate.
  • The world's biggest economic obstacle is deep spending cuts and shrinking economies among the 17 European countries that use the euro currency. Unemployment across the euro alliance hit a record 12.2 percent in April. The number of unemployed is on track to reach 20 million by year's end.
  • The biggest threat to Americans retiring over the next 25 years is too little savings. This is a more significant factor than the likelihood of reduced Social Security benefits, high out-of-pocket costs for Medicare recipients or nursing home expenses.

The stock market's gains, along with higher home prices, have helped create a "wealth effect." That's when people's rising wealth emboldens them to spend more. Their increased spending benefits the economy because consumers drive about 70 percent of U.S. economic growth.

Such spending may be helping to prevent any drag from a Social Security tax increase that took effect Jan. 1. The tax increase has left someone earning $50,000 a year with about $1,000 less to spend this year. A household with two highly paid workers has up to $4,500 less.

Americans as a whole have kept spending despite the higher Social Security tax. Instead, they've saved less. Spending grew at a 3.4 percent annual rate in the January-March quarter, the fastest pace in more than two years. The national savings rate fell to 2.3 percent from 4.1 percent last year.

"Consumers show no basic cultural change, in contrast to the wave of frugality embraced following the Depression of the 1930s," says Lynn Reaser, an economist at Point Loma Nazarene University in California.

Average pay has trailed inflation since the recession officially ended four years ago. Yet as long as job growth remains steady, more people will have income. And Americans will spend much of that money, economists say.

With their confidence at its highest point since 2008, Webman says consumers aren't likely to cut back. "If people feel better, the national pastime is shopping," he says.


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Big John

"Has the Fed's Stimulus Created a Stock Market Bubble"? Warren Buffet seems to think so and he said when the Fed stopped the corporate welfare the market would drop like a rock. Why have the ones who caused the financial meltdown are the same ones who have benefited and made tons of money the last five years? The people who saved and stayed out of debt and saw what was coming are the same people who have suffered and paid the highest price for this whole mess. Don Kings favorite line applies here, "Only in America".

June 06 2013 at 2:25 PM Report abuse +1 rate up rate down Reply
hustonlaw

This is all guesswork. The fact is that when the FED even hints that it may deflate its QE spending a little, the market drops like a rock. How is the punchbowl going to be removed without breakling it to smithereens?

June 06 2013 at 1:44 PM Report abuse +2 rate up rate down Reply
1 reply to hustonlaw's comment
theycallmeroy3

Because over longevity, its hard to hold stock prices down on really great companies. When investing seems complex, that's the time to keep it simple. Short positions can be crafty little creatures to mitigate- when you have parabolic stilt walkers.
Nobody wants to get hit with a margin call, no matter how much they deserve it. But sometimes you've got to slap the sh*t out of the sky, to get clear sailing.

June 06 2013 at 2:19 PM Report abuse rate up rate down Reply