Text book economics and finance say financial markets rise and fall with the economy: when gross domestic product (GDP) growth rate slows, financial market indices drop, and when GDP rises, the indices also rise.
Of late in this recovery since the crisis of 2007-2008, text books are having to scratch their heads. Indices are rising and falling based on the markets’ expectations of Federal Reserve’s monetary stimulus.
If economic data point to a strengthening economy, the Fed may withdraw its stimulus known as Quantitative Easing (QE), so the markets are falling, for example disappointed by good economic news in Fed’s June Beige Book, Dow Jones Industrial Average (DJIA) fell more than 200 points fearing pull back in Fed stimulus. On the other hand, weak economic news, pointing to continued Fed stimulus, is lifting indices.
Market incentives have become perverse – money given by the Fed and not the prospect of money earned by means of economic activity has become the driver of market ups and downs.
Economic recovery is the raison d être of QE. QE is not necessary upon a self-sustaining recovery, however slow or fast that recovery may be.
The markets ought to pick up their text books once again to remember to cheer on upon good economic news and fall when the news is not so good.
Stimulus is not for inflating the indices but is for economic recovery, meaning, job growth and GDP growth.
The markets would be better off reacting to economic news than to speculate about what the Fed would do with QE in response to the economic data.