How Does The Federal Reserve Impact The Stock Market

How does the Federal Reserve Impact the stock market? Well, as you know financial markets react to certainty – and uncertainty.

On Tuesday, the market was strong in reaction to Federal Reserve Chief Bernanke’s remarks. He assured investors that bank nationalizations aren’t needed. He also said that it was reasonable to expect that the economy could start a rebound by late-2009. His remarks brought clarity and direction – albeit without certainty.

So far this morning, the markets are giving President Obama’s address less than an enthusiastic reception. The reason? The speech had little in the way of clear-cut directives.

Besides the rhetoric, is there any reason to hopeful?

I believe there is. In fact, some of the bad economic news could actually be good news. Here’s what I mean.

The bad news is that , according to the Commerce Department, January housing starts dropped to a seasonally adjusted annual rate of just 466,000 units. That’s a whopping 79% decline from the peak 3 years ago. In fact, its the lowest number of starts in the post-World War II era. That’s bad news in the short-term. But it could be great news in the long-run. Here’s why.

Right now, we have a huge over-supply of homes on the market – and that supply is going to grow as foreclosures continue. (That means if you are saving money for a house, you may not need to save quite so much.) This over-supply is largely responsible for the steep decline in home prices. The Government is trying to increase demand by providing financial incentives to home buyers. The building industry is now doing its part to reduce supply. When demand goes up and supply goes down, prices go up.

So the decline in housing starts will help stabilize existing home prices eventually. IT will also create some fantastic entrepreneurial ideas for people awake enough to see them. When that happens, bank balance sheets will start to look healthier and that will help end the financial crisis.

How long will this take?

Unfortunately, I broke my crystal ball yesterday while I was making myself a bowl of oatmeal. So the bad news is, I don’t know when the crisis will end. The good news is, my oatmeal was delicious.

Do you have a crystal ball? When do you think we’ll get out of this mess?