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Do Political Parties Still Matter for the Financial Economy?

If it was not already so, it became apparent during the Covid-19 lockdowns that the financial and real economies were no longer conjoined.

In March of 2020, the S&P 500 bottomed after a decline of 34% from its all-time high, including a drop of 12% in a single day, only to reach a new all-time high less than 6 months later and continue to climb since.

Contrast this with the real economy where the effects of a skyrocketing unemployment rate and supply chain disruptions are still being felt today.

As of May 2021, the unemployment and labor force participation rates have not recovered to pre-lockdown levels while the nonfarm payroll employment remained 7.3 million jobs below pre-lockdown levels.

The point here is that the financial economy and the real economy are no longer strongly correlated. As millions of everyday Americans continue to dig themselves out of the government-induced recession, Wall Street has completely left them in the dust.

Can we attribute this financial market recovery to a particular political party’s policies? Or has the stock market disconnected from politics just as it has disconnected from the real economy?

What Drives the Markets

There was a time not so long ago when business fundamentals like revenue, earnings, and growth dictated supply and demand for market participants.

And one could argue this is still true for the real economy. But more recently, the stock market has detached from the realities of the real economy. This became apparent during the pandemic when the performance of the stock market did not reflect the reality of most American’s lives.

So, what has driven the financial markets to detach from the real economy? Government manipulation.

Since about 1980 when Paul Volcker famously hiked interest rates to kill off the runaway inflation of the 1970s, interest rates have been steadily declining. For much of the latter half of the 20th century, investors could earn a decent real return on Treasury securities that effectively guaranteed their investment.

When factoring in the rate of inflation of the present day, investors are earning a negative real return on a 10-year Treasury that yields less than 1.5%.

These artificially low rates are a result of the Federal Reserve’s monetary stimulus programs and historic asset purchase programs that are holding interest rates near zero.

Although the Fed started purchasing securities back in 2008 during the Great Financial Crisis, the quantity has recently skyrocketed to $120 billion a month of Treasury securities and mortgage-backed securities, bringing its balance sheet to almost $9 trillion.

Not only are these low-interest rates ruining returns for risk-averse bond investors, but they are forcing investors farther and farther out on the risk curve into assets like stocks because they do not have many other options to get a return on their capital.

The Federal Government issued stimulus checks throughout the lockdown period to amplify these market manipulations that pumped money into financial markets because folks did not have anything else to spend their money on.

A survey led by Deutsche indicated that of the 73% of respondents who received the first round of stimulus payments, 53% invested at least some of their money into the stock market.

Many government-sponsored dollars went into speculative “meme stocks” that lacked any previously mentioned underlying fundamentals that used to dictate stock market prices. Rather, government money printing, interest-rate manipulation, and online forums have dictated surges in the stock market as of late.

Political Affiliations

As it turns out, government money printing and Fed asset purchase programs do not seem to have political affiliations.

It was after all a Republican who signed off on the first rounds of stimulus checks and a Republican who appointed the Federal Reserve Chair responsible for these historic asset purchase amounts. So much for fiscal conservatism.

After the election of a Democrat in November 2020, nothing seems to have changed as government spending and money printing continue to accelerate and the Fed has shown no real signs of tapering its asset purchases.

Hysteria would be an appropriate word to describe the current economic environment in the United States. How long the hysteria will last is anyone’s guess.

It would, however, be a good guess to assume neither political party can be counted on to bring the financial market back to the economic reality facing the rest of the nation.

Until something changes, expect disparities between the real and financial economy to continue no matter which political party is in charge.

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