The Fed Or the Fundamentals? What's Behind Stock Market Moves?

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What's driving the stock market - the Fed or company fundamentals?

The answer, of course, depends whom you ask.

Has most or all of the growth in the market over the past few years been due to the Fed's massive QE easy money stimulus?

Or is it fundamentals like earnings per share and the price/earnings ratio?

We asked three experts to weigh in: Money Morning Chief Investment Strategist Keith Fitz-Gerald, Money Morning Capital Wave Strategist Shah Gilani and Brian Wesbury, the chief economist at First Trust Advisors.

Here's their take.

Keith Fitz-Gerald

"I think this rally has been all about Fed Chairman Ben Bernanke for a long time," Fitz-Gerald said. "And we know the Fed's goal was to inject trillions of dollars into the economy in an effort to stimulate it and what that in fact produced was a bubble of significant proportions that artificially sustained and built up the stock market."

But Fitz-Gerald said he's not too concerned about the Fed's signaling it will taper quantitative easing or about the plunge in stock prices that followed.

"I don't lose sleep over what just happened," Fitz-Gerald said. "I saw this coming from a mile away. I've been telling people the train wreck is coming and now we have it."

Fitz-Gerald said the selloff proves capitalism will ultimately fix the economy.

"You know the Fed's been manipulating the market for so long that the markets have forgotten what risk is. And the bloodletting, this rout of stocks, is proof that capitalism exists. People bought and sold."

After the recent downturn, Fitz-Gerald said, investors who choose stocks carefully can profit.

"If the reasons you own them remain intact - for example, they've got a great product, they've got international market share, they've got a strong balance sheet, they've got disciplined executives - if all that's still valid, then history suggests big pullbacks will be kind to you. They're actually buying opportunities."

Shah Gilani

Gilani said he still can't fathom why the Fed announced last week that it'd scale back QE.

"Personally, I don't understand why they did that," he said. "Why didn't they just shut up and say, 'We're watching to see how things go?' They panicked everybody."

Gilani pointed out the stimulus lowered interest rates, enabling corporations to borrow money at low rates in the bond market and bringing down mortgage rates to near-historic lows.

"What about people buying houses?" he said. "There's supposedly this housing recovery. Now rising rates are going to choke off that. So everything comes into question because of the Fed's tapering. It's like all bets are off now."

Gilani notes that the Fed's signal comes amid a credit crunch in China that has heightened fears the country's economic growth won't continue.

That, in turn, could hurt the U.S. and global economy and hit stocks here at home, Gilani said.

Speaking of China and other emerging markets, Gilani said, "Now, if those foreign markets start to slow down and the dollar rises against these other currencies, U.S. export products are not going to do as well and the export market, which has been a source of growth for U.S. corporations, will slow down or stop."

With the scaling back of QE now on the horizon, Gilani said investors must choose stocks more carefully.

"It's a stock-picker's market now," he said. "You can't throw darts at the wall anymore and say, 'Well, my dart landed on these stocks. Let's buy them.'"

Brian Wesbury

Financial news can drive the stock market on an hourly, daily or even weekly basis, but not over the long haul, Wesbury says.

Yes, he says emphatically, fundamentals still do matter.

"Some people would say, 'Well, the only fundamental that matters is the Fed. It's all a sugar high and that explains everything.' I'm not in that camp," Wesbury said.

"I do believe there's fundamental growth happening, that new things are being invented: fracking, the cloud, the smartphone, 3D printing, the tablet, nanotechnology, biotechnology."

Wesbury said he gets tweets from people who make the "sugar high" argument. "Every time I get that tweet from somebody, I tweet back, 'Oh, go tell that to the people who invented fracking. That oil coming out of the ground? It's all because of Ben Bernanke.'"

He points out P/E ratios are no higher than when QE began.

"And if this was all a sugar high, if this was all phony, you should have seen P/E ratios up because you're just driving asset prices up regardless of the growth of earnings or anything else. ... That's what a sugar high would mean to me, that markets go up no matter what happens.

"I do believe that productivity's happening and I do believe that productivity's driving earnings and I do believe that stock prices have responded to those earnings and that from a valuation point of view, we still aren't expensive. In fact, I think we are cheap in equities."

How cheap? Based on "conservative" equity models, Wesbury said, the stock market's about 35% undervalued.

What Do You Think?

Is the stock market driven mainly by the Fed's actions? By fundamentals? Some of both? Let us know what you think - leave a comment below.

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