Equity Markets and Equity Markets and Measures of WealthMeasures of Wealth

By: Amanda, Drew, Joe, Mark, By: Amanda, Drew, Joe, Mark, and Ryanand Ryan

Data Studied (I)Data Studied (I)

Quarterly trends of the stock Quarterly trends of the stock market from Jan 1, 2004 to Dec market from Jan 1, 2004 to Dec 31, 200631, 2006

Compared to: Compared to: Net worth and single-family home Net worth and single-family home

purchases (personal)purchases (personal) NYSE, DOW, S&P 500 (business NYSE, DOW, S&P 500 (business

spending)spending) GDP (national)GDP (national)

Data CollectedData Collected

Mainly through SurveysMainly through Surveys i.e. U.S. Censusi.e. U.S. Census

Shows government info on housing Shows government info on housing market and incomemarket and income

Given every 10 yearsGiven every 10 years

Gross Domestic ProductGross Domestic Product

GDP= consumption + GDP= consumption + investment + gov’t spending + investment + gov’t spending + (exports - imports)(exports - imports)

Tracked by the Bureau of Tracked by the Bureau of Economic AnalysisEconomic Analysis

Equity Markets (II)Equity Markets (II)

Indexes are used to measure the Indexes are used to measure the performance of stocksperformance of stocks

NYSE (New York Stock Exchange)NYSE (New York Stock Exchange) DOW (Dow Jones Industrial DOW (Dow Jones Industrial

Average): 30 of the largest and most Average): 30 of the largest and most widely held public companies in the widely held public companies in the USUS

S&P 500 (Standard & Poors): S&P 500 (Standard & Poors): measures the 500 large-cap measures the 500 large-cap corporationscorporations

Recent Stock Market Trends

-6.00%-4.00%-2.00%0.00%2.00%4.00%6.00%8.00%

10.00%12.00%

2004-I

2004-II

2004-III

2004-IV

2005-I

2005-II

2005-III

2005-IV

2006-I

2006-II

2006-III

Quarter

% Cha

nge

NYSE

DOW

S&P 500

Comparison of Net Worth and Comparison of Net Worth and the Stock Market (III)the Stock Market (III) Kevin Warsh, Board of Governors Kevin Warsh, Board of Governors

“Markets affect monetary policy “Markets affect monetary policy predominately through the predominately through the information provided by asset information provided by asset prices.”prices.”

Post 9/11, Fed saw decrease in net Post 9/11, Fed saw decrease in net worth through lack of confidence in worth through lack of confidence in stock market and began the 3 yr stock market and began the 3 yr drop in the Fed Funds rate from drop in the Fed Funds rate from 6.5% in Jan 2000 to 1% in July 20046.5% in Jan 2000 to 1% in July 2004

Housing MarketHousing Market

6 in 10 homeowners have more equity than 6 in 10 homeowners have more equity than stock wealthstock wealth

Lowering of interest rates made it cheaper to Lowering of interest rates made it cheaper to borrow money, causing mortgage rates to borrow money, causing mortgage rates to lowerlower

Caused an increase in housing market, and a Caused an increase in housing market, and a decline in the equity marketdecline in the equity market

This in turn, sparked the economy’s growth to This in turn, sparked the economy’s growth to all-time highs and due to inflationary pressures, all-time highs and due to inflationary pressures, the Fed raised the Fed. Funds ratethe Fed raised the Fed. Funds rate

Increased values in real estate caused Increased values in real estate caused individual’s net worth to increase alsoindividual’s net worth to increase also

Recently, housing mkt has decreased and has Recently, housing mkt has decreased and has sent equity down and net worth has followedsent equity down and net worth has followed

Commodity MarketsCommodity Markets

Provided the greatest inflationary Provided the greatest inflationary pressure on the economy and forced pressure on the economy and forced rate increasesrate increases

Ben Bernanke: “One likely source of Ben Bernanke: “One likely source of this deceleration (in consumer this deceleration (in consumer spending) was higher energy prices, spending) was higher energy prices, which have adversely affected the which have adversely affected the purchasing power of households and purchasing power of households and weighed on consumer attitudes…”weighed on consumer attitudes…”

Force consumers to spend money Force consumers to spend money on goods and services instead on on goods and services instead on increasing their net worthincreasing their net worth

Stock Market Effect on Stock Market Effect on Consumption (IV)Consumption (IV) NY FRB compares this to look for a way to NY FRB compares this to look for a way to

predict the behavior of consumers after an predict the behavior of consumers after an upward or downward trend in the stock upward or downward trend in the stock marketmarket

For every $1 increase in wealth, avg For every $1 increase in wealth, avg consumption increases by about $.03 to consumption increases by about $.03 to $.04$.04

However, is not correlated with future However, is not correlated with future consumption growth and cannot predict itconsumption growth and cannot predict it

Today’s stock market growth affects Today’s stock market growth affects today’s consumption growth, not today’s consumption growth, not tomorrow’stomorrow’s

How Fed actions affect How Fed actions affect ConsumptionConsumption Decreases the Fed Funds RateDecreases the Fed Funds Rate This decreases the cost of This decreases the cost of

borrowing money, encouraging borrowing money, encouraging consumers to borrow money to consumers to borrow money to increase consumption spendingincrease consumption spending

Business Spending and the Business Spending and the Stock Market (V)Stock Market (V)

Business Spending (cont.)Business Spending (cont.)

There is somewhat of a correlation There is somewhat of a correlation between the equity market and between the equity market and business spendingbusiness spending

Companies perform well, stock Companies perform well, stock prices go up, causing equity to rise, prices go up, causing equity to rise, companies then expand and spend companies then expand and spend more on facilities, employees, and more on facilities, employees, and projectsprojects

Thus, business spending increasesThus, business spending increases

Business Spending (cont..)Business Spending (cont..)

Avg Business spending growth per yr over Avg Business spending growth per yr over last two years: 9%last two years: 9%

Avg GDP growth per yr over same period: Avg GDP growth per yr over same period: 7% 7%

Percent of business spending at the end of Percent of business spending at the end of 2005: 10.75%, well below average2005: 10.75%, well below average

Could be due to recent accounting Could be due to recent accounting scandals and passing of the Sarbanes-scandals and passing of the Sarbanes-Oxley act requiring companies to spend Oxley act requiring companies to spend more money ensuring their books are in more money ensuring their books are in orderorder

Businesses investing more overseasBusinesses investing more overseas Business spending is expected to grow Business spending is expected to grow

steadily throughout the yearsteadily throughout the year

GDP and the Stock Market GDP and the Stock Market (VI)(VI)

Equity Markets vs. GDP

-0.06

-0.04

-0.02

0

0.02

0.04

0.06

0.08

0.1

0.12

Quarters

Perc

ent C

hang

e

Gross domesticproductDOW

NYSE

DOW

S&P 500

GDP and the Stock Market GDP and the Stock Market (cont.)(cont.) Std dev for the % change in GDP is Std dev for the % change in GDP is

about .3, as opposed to about 3.2 for about .3, as opposed to about 3.2 for the DOW...little to no correlationthe DOW...little to no correlation

Partly de to the fact that GDP Partly de to the fact that GDP includes government spending, includes government spending, which is not portrayed very well on which is not portrayed very well on the stock marketthe stock market

Although the indexes take into Although the indexes take into account a large portion of business account a large portion of business spending, it does not account for all spending, it does not account for all of itof it

FOMC and GDPFOMC and GDP

If GDP increases rapidly, it can If GDP increases rapidly, it can be seen as a sign of inflationbe seen as a sign of inflation

The Fed will then raise the Fed The Fed will then raise the Fed Funds Rate to counteract the Funds Rate to counteract the inflationinflation

However, the GDP is slowly However, the GDP is slowly increasing, leaving one to increasing, leaving one to believe that the Fed Funds Rate believe that the Fed Funds Rate should not be adjustedshould not be adjusted

Conclusion (VII)Conclusion (VII)

Keep Fed Funds Target Rate at 5¼Keep Fed Funds Target Rate at 5¼%%

Indicators have been mixed citing Indicators have been mixed citing stronger than expected job growth stronger than expected job growth and decreases in overall business and decreases in overall business spendingspending

Inflationary pressures do exist, but Inflationary pressures do exist, but business expansion should grow at a business expansion should grow at a moderate pacemoderate pace

Future changes will depend on Future changes will depend on inflation and future outlooksinflation and future outlooks