The correlation between QE and the stock market

The following is a direct quote of this article .

And what will a slight taper do?
Chaim

P.S. If anyone knows exactly how to get the weekly data from the Fed’s site please let me know. I like to verify everything firsthand. Thanks.

Hey Chaim,

You can find the Fed’s Balance Sheet records at this website:

http://www.federalreserve.gov/monetarypolicy/bst_recenttrends.htm.

There’s a smorgasbord of information available which tracks the growth of the fed’s monetization of the US debt obligations. It is quite a quagmire they have dug for themselves (and this country). It’s all a giant science experiment and we’re the test subjects. Let’s all hope the economy really takes off (a’ la 1982-1999), then the Fed’s balance sheet and QE will be a moot subject.

On the other hand, take a look at the reduction in the Fed’s assets in mid/late 2008. The Fed was liquidating its balance sheet, pushing more assets (increasing supply and reducing prices further) into the teeth of the worst economic crisis in our lifetime. Think they’ll get it right this time?

There is a pretty good correlation between earnings and stocks also, as the tools on the site prove.

How about a another view -

http://oldprof.typepad.com/a_dash_of_insight/fed-policy.html

Correlation is not causation. In addition, as per the graph the correlation need not be permanent.

That said the logic is in support of FED purchases driving stock prices. i.e. When an institution sells a bond (to the FED) there is a reasonable expectation that they will buy another financial asset with the money. This would likely be either a lower quality bond or a stock.

The 2011 to 2013 period would indicate that tapering may well lead to a short term correction, but that a recovery (in stock market) is not contingent on further buying by the FED.

With regards to reducing the FED balance sheet, my view has always been that the FED will hold these assets to maturity (i.e. not requiring for anyone to buy them). There is absolutely no pressure to sell them unless inflation becomes difficult to control (or lie about).

A few weeks ago the Fed announced a small taper, and the stock market jumped up. This is inconsistent with the story that stocks are going up only because of QE.

I think Fed action can move stocks, but I don’t think it is the primary mover of stocks. Stocks have been going up because (1) corporate earnings have been going up (2) stocks were too cheap during the finanical crisis (3) the economy is slowly improving.

Another aspect of the Fed driven low interest rate is that it enabled companies to sell very cheap bonds which they then used to buy back shares with. This has driven up all of the EPS numbers. I think as interest rates rise, you will see less share buy backs. Counter to that, we could see a nice swing to dividend paying stocks as people finally move from bond funds to equity funds. That migration may finally begin in earnest, at least until bond prices stabilize.

Here is a chart that I think you all would find value with.


Mister Chang said:[quote]
A few weeks ago the Fed announced a small taper, and the stock market jumped up. This is inconsistent with the story that stocks are going up only because of QE.
[/quote]
In my newsletter last Sunday night I wrote, “Stocks surged in mid-December when the Fed first announced that it would begin ‘tapering’ the $10-billion-per-month QE in early 2014. If a reduction in QE is considered a reduction in stimulus, why would markets surge? The reason is that, in the financial markets, the reaction to Fed action is always an expectations game. The Fed announced a smaller cut in bond-buying than the stock market expected, so investors treated the Fed decision as a move in the direction of stimulus.”

Read: “Make no mistake about the taper – the Fed wishes it could stimulate the economy more:” http://qz.com/159821/make-no-mistake-about-the-taper-the-fed-wishes-it-could-stimulate-the-economy-even-more/

Another good read is John Hussman’s open letter to the FOMC, criticizing he asset bubble that’s been created: [url=http://www.hussmanfunds.com/wmc/wmc131125.htm]http://www.hussmanfunds.com/wmc/wmc131125.htm[/url]

If there’s any question about whether or not stocks (overall) are in an asset bubble, Mark Hulbert has a good article this weekend outlining six valuation ratios saying that the market is overbought: [url=http://www.marketwatch.com/story/six-ratios-say-this-market-is-very-overbought-2014-01-17]http://www.marketwatch.com/story/six-ratios-say-this-market-is-very-overbought-2014-01-17[/url]

This is not to say that the market is immediately going to collapse. There is good reason to believe that the market is not yet sufficiently overheated to be at a pre-collapse peak. The general public has yet to return to stocks, as retail investors notoriously do at the end of a run. There has also never been a market top when the economy is struggling. But in 2014 we should see the economy attain escape velocity, and likely the stock market will shoot further skyward. I expect to see near 2000 on the S&P500 before a downturn begins. $SPX 1996 is what our technical work is pointing to as a top. Our approach: ride the bucking bronco with undervalued equities, and go with a broad-market inverse ETF on the downturn!

[quote]
Hey Chaim,

You can find the Fed’s Balance Sheet records at this website:

http://www.federalreserve.gov/monetarypolicy/bst_recenttrends.htm.
[/quote]Thanks Christopher Michaels. That’s exactly what I was looking for.

Notice the correlation between the Fed’s actual balance sheet (not the Fed’s announcements) and the market. This seems to prove Ray Dalio’s theory right; that the market overall is not driven by sentiment as much as it is driven by supply and demand. The ones who sold bonds to the Fed got money which they put into other investments.

It’s also interesting to me how the the abrupt end of QE2 (June 30,2011) happened right before the European debt crisis. Correlation may not always be causation but it’s a good place to look.

Chaim

For a step by step replay of QE and the stock market see this link.