The Dow And The Federal Reserve's Transitions

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Includes: DDM, DIA, DOG, DXD, SDOW, UDOW
by: J.J. McGrath

Loose monetary conditions are associated with rising share prices and tight monetary conditions are associated with falling share prices, all other things being equal (or even unequal at times) in the U.S. equity market. As a result, many stock-market participants keep one or both eyes on the operations of the Federal Reserve as a matter of course.

With a U.S. Senate vote to confirm Janet L. Yellen as the next head of the American central bank anticipated before the Federal Open Market Committee meeting Jan. 28-29, my own brand of FedWatching led me to carry out a simple-minded historical study of the associations between changes in the institution's leadership and movements of the Dow Jones Industrial Average (DJIA) during the subsequent trading year in each case. Basically, I aimed to determine whether there is any evidence of a cause-and-effect relationship between the two variables that would be helpful to me as a financial-market participant.

Since the Federal Reserve was founded a century ago, it has had 14 leaders, known as the chairman at present and as the governor in the past, according to the central bank's online site. These Fed heads and their first days in office are as follow:

• Charles S. Hamlin, Aug. 10, 1914.

• William P.G. Harding, Aug. 10, 1916.

• Daniel R. Crissinger, May 1, 1923.

• Roy A. Young, Oct. 4, 1927.

• Eugene Meyer, Sept. 16, 1930.

• Eugene R. Black, May 19, 1933.

• Marriner S. Eccles, Nov. 15, 1934.

• Thomas B. McCabe, April 15, 1948.

• William McChesney Martin Jr., April 2, 1951.

• Arthur F. Burns, Feb. 1, 1970.

• G. William Miller, March 8, 1978.

• Paul A. Volcker, Aug. 6, 1979.

• Alan Greenspan, Aug. 11, 1987.

• Ben S. Bernanke, Feb. 1, 2006.

In conducting the study of the 13 Federal Reserve leadership changes and their associations with the movements of the Dow over the subsequent trading year in each case, I appropriately enough employed the DJIA daily figures at the Federal Reserve Economic Data (FRED) site hosted by the Federal Reserve Bank of St. Louis. In each case, I used the last trading day before the first day in office of the new Fed head as my baseline. In the definitions of the study, I characterized a trading year as consisting of 12 trading months and a trading month as consisting of 21 trading days, meaning one trading year equals 252 trading days.

Every Picture Tells A Story

Below are four of the many charts produced as results of the study. All the charts display the DJIA's advance or decline compared with the baseline. The first two charts center on data related to trading days, one presenting the mean and the other presenting the median. The last two charts center on data related to trading months, one presenting the mean, plus and minus the standard deviation, and the other presenting the median.

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Source: This chart is based on DJIA daily figures at the FRED site.

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(Click to enlarge)

Source: This chart is based on DJIA daily figures at the FRED site.

Click to enlarge
(Click to enlarge)

Source: This chart is based on DJIA daily figures at the FRED site.

Click to enlarge
(Click to enlarge)

Source: This chart is based on DJIA daily figures at the FRED site.

The Bottom Lines

As mentioned at the outset, the aim of my simple-minded historical study was to determine whether there is any evidence of a cause-and-effect relationship between changes in the Federal Reserve's leadership and movements of the DJIA during the subsequent trading year that would be helpful to me as a financial-market participant.

In making this determination, I found it necessary to develop comparative benchmarks employing the DJIA annual figures for the calendar years from 1914 to 2012 at the FRED site. Using these data, I calculated the Dow's yearly mean advance as 6.70 percent and its median advance as 6.74 percent during the relevant period. These numbers compare with the Dow's mean gain of 5.07 percent and its median gain of 8.92 percent found in my study.

Based on my analysis of all the data in the study, I am therefore prepared for a possible below-average advance in the DJIA and above-average volatility in it during the trading year subsequent to the expected Federal Reserve leadership transition in the wake of the FOMC meeting Jan. 28-29. Naturally, I am aware there are only 13 cases in the relevant data set, so all conclusions derived from it are subject to pretty large margins of error. And, of course, the Yellen Fed probably will prove itself indistinguishable from the Bernanke Fed in terms of the quantitative-easing and zero-interest-rate policies that have created the asset-price bubbles in multiple financial markets, so the merrymaking in the equity market could continue longer than indicated by the historical data.

As a former Boy Scout, however, I believe it best at all times and in all places to be prepared.

Author's Note: Given the 13 Federal Reserve leadership transitions to date and a Friday the 13th happening this week, I would be willing to publish a chart associated with each one of the 13 Fed head transplants, either on Seeking Alpha proper or on J.J. McGrath's Instablog, should 13 folks indicate their interest in them in the below "Comments" section. Please advise.

Disclaimer: The opinions expressed herein by the author do not constitute an investment recommendation, and they are unsuitable for employment in the making of investment decisions. The opinions expressed herein address only certain aspects of potential investment in any securities and cannot substitute for comprehensive investment analysis. The opinions expressed herein are based on an incomplete set of information, illustrative in nature, and limited in scope, and there are limitations to their accuracy. The author recommends all investors conduct detailed investment research of their own. The information upon which this article is based was obtained from sources believed to be reliable, but it has not been independently verified, which means the author cannot guarantee the accuracy of this information. In addition, the opinions expressed herein reflect the author's best judgment as of the date of publication, and they are subject to change without notice.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.