It's the Yellen Rally, Not the Trump Trade

(Bloomberg View) -- President Donald Trump is nothing if not persistent when it comes to taking credit for the best U.S. stock market since 2013. That puts him at odds with almost every arbiter, from Business Insider to The Motley Fool to the New York Times to the Fact Checker at the Washington Post to Yahoo.com. All say the boast is not credible, mostly because Trump inherited an economy in its eighth year of expansion with the lowest interest rates for such a boom in at least half a century.

Economist Larry Summers, director of the Mossavar-Ragmani Center for Business and Government at Harvard's Kennedy School of Government and a former Treasury Secretary under President Bill Clinton, told Bloomberg: "Hey, it's a preposterous claim," one that is "highly irresponsible for a president to make."

Here's the heart of his argument:

Markets all over the world have rallied very substantially, many more than the United States, calling into question the idea that it's specifically what our president is doing. And if you look at different stocks, it's not the case that the ones that are most affected by the president's tax policies are the ones that have, by any substantial margin, rallied the most.

Summers is right. And if any individual can reasonably take credit for the bull market, she would be Janet Yellen, the first woman to lead the U.S. Federal Reserve during its 105-year history. Mandated by Congress to create a monetary policy that maximizes employment, stabilizes prices and moderates long-term interest rates, the Fed under Yellen is outperforming her recent predecessors.

Unlike any of them, Yellen communicated with consistent clarity to chief executives and investors a message that increasingly proved accurate about the economy's steady improvement. Her effectiveness is ratified by the unprecedented collapse of fluctuations in all markets since she assumed control of the Fed.

Stocks rise when companies flourish, something that happens only when the financing of business is deep and durable. The Fed, more than any institution, is responsible for enabling such confidence. The implied volatility of U.S. government securities, the measure of investor uncertainty about the economy, diminished to a record low since the metric was introduced in 1988, according to data compiled by Bloomberg. Its present reading of 47.7 percent — the range that investors expect prices to swing in the year ahead — is well below the average reading during Yellen's four-year term, which ends in February, 68 percent. The average under Yellen's immediate predecessors, Ben S. Bernanke and Alan Greenspan, was 95 percent and 102 percent respectively.

In the market for U.S. stocks, implied volatility is shrinking to little more than 9 percent, another record low. The average reading for Yellen's Fed is 14 percent, substantially less than the 22 percent and 19 percent that prevailed, respectively, when Bernanke and Greenspan were chairmen, according to Bloomberg data.

The paucity of extreme market fluctuations is a reflection of a U.S. economy adding jobs for 85 consecutive months, the longest streak since such data was compiled in 1939. While the U.S. unemployment rate was greater than the average of the Group of Eight economies before 2014, it fell below that benchmark when Yellen took over the Fed. The favorable gap has widened since then.

Between 2010 and 2014, U.S. gross domestic product mostly was a G-8 laggard. During the four years since Yellen became chair of the Fed, the U.S. joined the G-8 leaders and economists surveyed by Bloomberg say U.S. GDP will be No. 1 in 2018 and 2019. No Federal Reserve during the past three decades has come closer to meeting its stated target for inflation than the Yellen-led Fed, as measured by the difference between monthly inflation and the Fed's 2-percent target. The average gap was twice as wide when Bernanke and Greenspan were chairmen, according to data compiled by Bloomberg.

The credit markets during the period of Yellen's Fed leadership provide the biggest change for the better for American companies. The ratios of net debt to Ebitda — earnings before interest, taxes, depreciation and amortization, a measure of profit — for the S&P 500 and Russell 3000 remain near the record low of 2014, meaning that corporate profits and cash on hand are increasing faster than indebtedness. Low debt ratios tend to indicate that companies are borrowing more money and are more profitable at the same time. 

This rare convergence boosted the earnings per share of companies in the S&P 500 to more than $118, a record valuation since such data was first compiled in the 1950s.

Yet investors are only paying 19 times earnings forecast by analysts, which is 27 percent below the high in 1999. So even though American companies are the most profitable in history, their shares remain relatively cheap. 

"What the market has responded to in recent months has been the micro economics of individual companies who for a variety of reasons are seeing substantial increases in profits and cash flows," Summers said. "And that's what's been driving the market rather than the macro news out of Washington." 

 (With assistance from Shin Pei)

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Matthew A. Winkler is a Bloomberg View columnist. He is the editor-in-chief emeritus of Bloomberg News.

1. Trailing 12-month EPS.

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