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FOMC Asset Purchases And The S&P 500
Submitted by Lance Roberts of STA Wealth Management,
I have been pretty rough on the market over the last couple of days (see here and here) as to why the markets are unlikely to repeat the secular bull market of the 80's and 90's anytime soon. However, as I have stated repeatedly over the last several months, such comments do not mean that the markets can not go higher in the near term. We are reminded of this fact in a recent note from Bespoke Investment Group which discussed the impact of the FOMC's large-scale asset purchase programs (known quantitative easing or QE) on the financial markets. To wit:
"Throughout the last couple of years we have been updating a version of the chart below which overlays each of the FOMC’s asset purchase plans on the chart of the S&P 500. As one can clearly see in the chart and the table below, periods where the Fed was buying bonds have seen stocks rally, whereas periods where the Fed was not actively purchasing bonds saw two of the largest pullbacks for the S&P 500 during this bull market."
This is something that I discussed previously. The chart below shows the historical correlation between increases in the Fed's balance sheet and the S&P 500. I have also projected the theoretical conclusion of the Fed's program by assuming a continued reduction in purchases of $10 billion at each of the future FOMC meetings.
If the current pace of reductions continues it is reasonable to assume that the Fed will terminate the current QE program by the October meeting. If we assume the current correlation remains intact, it projects an advance of the S&P 500 to roughly 2000 by the end of the year. This would imply an 8% advance for the market for the entirety of 2014.
Such an advance would correspond with an economy that is modestly expanding at a time where the Federal Reserve has begun tightening monetary policy. (Yes, Virginia, "tapering" is "tightening.) David Rosenberg charted this in his note yesterday (via PragCap):
With this in mind, Bespoke made a very salient point.
"With the benefit of hindsight it was easy to see that the economy was not strong enough to stand on its own following the last two times the Fed ended its bond buying programs.
While the S&P 500 has continued to rally since the taper was announced, volatility has seen an uptick. This leads to the question once again over whether the US economy can stand on its own when QE3 completely winds down, not to mention when the Fed actually hikes rates?"
This is a crucial question considering that the economy is already growing at sub-par rates. As I discussed recently:
"Since 1999, the annual real economic growth rate has run at 1.94%, which is the lowest growth rate in history including the 'Great Depression.' I have broken down economic growth into major cycles for clarity."
Such weak levels of economic growth does not leave much wiggle room to absorb an exogenous event, or even just a normal downturn, in an economic cycle.
With deflationary pressures still prevalent in the economy, from rising productivity, excess labor supply and sluggish wage growth, there is little ability for increases in consumption to drive continued economic expansion. The chart below shows the "consumption function."
Through 2008, consumption as a percentage of the economy, grew from roughly 62% to 68%. That increase in consumption, which supported economic growth, was derived through an $11 Trillion increase in real, inflation adjusted, household debt. However, therein lies the problem. If the Federal Reserve does begin to hike interest rates in an already anemic economy, can consumers absorb higher borrowing costs without impeding their consumption? The answer is shown in the comparison of real personal consumption expenditures as compared to economic growth.
It is unlikely that the consumer can increase debt enough to substantially increase economic growth. With economic growth heavily dependent on personal consumption, even the much anticipated revival in corporate capex spending will be unlikely able to "carry the ball" on its own.
It is here that Bespoke's question of whether the economy can survive without the support of the FOMC becomes critical. As I stated yesterday:
"It is quite apparent that the ongoing interventions by the Federal Reserve has certainly boosted asset prices higher. This has further widened the wealth gap between the top 10% of individuals that have dollars invested in the financial markets, and everyone else.
However, while increased productivity, stock buybacks, and accounting gimmicks can certainly maintain an illusion of corporate profitability in the near term, the real economy remains very subject to actual economic activity. It is here that the inability to releverage balance sheets, to any great degree, to support consumption provides an inherent long term headwind to economic prosperity."
The real challenge for the Federal Reserve is deciphering between economic statistics at the headline and the real economy. While much of the economic data does show improvement from the recessionary lows, it also suggests that the real economy is far too weak to stand on its own.
If the Fed is indeed caught in a liquidity trap, then the current withdrawal of support will quickly show the cracks in the economy pushing the Fed back into action. I think the real question that needs to be asked is:
"When will the financial markets fail to respond to Fed actions?"
It is at the point of "monetary impotence" where the word "risk" takes on a whole new meaning.
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If the Fed quits QE...then has to jump back in...I see that as a big turning point...nationally for sure...but internationally also.....the rest of the world will know that we are going to print to infinity...and will take actions to protect their countries and curriencies...
I think Japan has had somewhere in the teens of QE-like "stimulus programs" since the early 90s. The world keeps crawing back to the Yen over.... and over.... and over.... and over again.
If we're "in a Liquidity Trap"?
You gotta be fucking kidding me?
What the fuck do you think we're in genius?
This is shit has been going on for way too long.
Wake up, Progressives!
"If the current pace of reductions continues..."
But the reductions haven't continued. Just ask Belgium.
Seriously, the US government wants to continue running large deficits. For that to happen, they MUST sell UST. But the Fed has announced that it is tapering, and history before QE1 showed that foreign governments were not in the buying mood (one might assume that condition still holds). So who will be buying these bonds?
The only other options instead of creating treasuries (i.e. fake assets) is to print explicitly (i.e. fake money) or start selling/confiscating real assets. Unless there is another fake asset that the US government can create that I'm missing.
This is why the theory of Fed "shadow ops" like Belgium is so compelling.
MyRA...
I long for the day when Joe six pack will know that QE = printing money.
I long for the day Joe six pack understands the implications of printing money, even in vague terms.
-34%
Anyone who thinks that removing $1 trillion a year ($85 billion a month of Fed purchases) of monetary stimulus from the economy will not have a significant impact is either delusional, in denial, or lives in the state of Washington or Colorado. When the US economy/capitalist system allowed the Fed to become the single biggest factor in determining how and when markets perform, the game was over. The Fed's influence has only intensified over the past 15 to 20 years which is a direct correlation to how the economy has "not" performed.
One simply needs to look back at the Fed policy changes in 1998/1999 and the resulting impact of the dot.com/tech crash shortly after and then again in 2006/early 2007 bringing on the Great Recession financial meltdown shorly after. Decreasing purchases from $1 trillion a year to zero is a major policy change that will have dramatic impacts around the globe (which has already started). The only issue is when which brings up my next point. The equity markets are the last parties to actually "get" and act on the message. Credit is getting and acting on the message today. But equity, with the message already being relayed loud and clear, will wait until the very end to actually act on the message. Every bull market ends with the bulls kicking and screaming until the bitter end. No different this time around as the bulls will kick and scream for another month, two, three or maybe even six but evetually, succumb to the beast the Fed has created.
The Fed policy change started in December and is in full force. My guess is that it will take six to 12 months to be fully accepted by the equity markets. Until then, the bulls will continue to spew their venom in hopes and prayers that it is truly different this time. But the only thing that will be different will be the volitility of the moves as each correction is becoming more and more extreme as the Fed's actions become more and more aggressive.
As the manipulation ends/(restarts?), he who sells first sells best.
We all know it's a game now,do you really believe after 7 trillion in debt and 3 trillion in QE they will just walk away ? The Feds need to keep the stock market propped up for the Pension plans,think about how much the govts and companies would have to add to their plans to keep them funded.They may let the market dump a little bit before they print until the end.
Full force? Didn't the FED QE $105B in Feb? Weren't they supposed to only do $65B?
If the ecomony was a woman, Feb was a heavy flow month for the FED.
When will the bond market force a real rise in rates? 2014, 2015? That's the big question. That's when Japan implodes and very very bad things will start happening.
If this scenerio were to play out with regards to tapering the market would never get to 2000. People will anticipate the lack of liquidity and/or weakening of the economy and it becomes who can get through the door first. I would guess that would occur around 1884... oh wait
According to Richard Duncan, who studies credit, liquidity starts drying up at the end of the 2nd qtr. I look for a rocky summer and fall. Maybe the Fed will act, but the people are on to them. They may not stop taper and instead start charging the member banks interest on reserves. Now that would be interesting!
. 'monetary impotence'
+ 100 for that phrase.
The Key here is not to run out of " students " to loan money to.
It's amazing to see the aggressive tactics these student counselors employ to hook these kids. My youngest who is not sure of her direction is running out of her allotted credits she can accrue at community college. She is being pressured to transfer to a 4 year institution " because everyone needs an education". We refuse to do this unless she has a major that spending that amount of money would make sense. I've had people tell me as a parent you must fund an education " because a good parent must give his child any chance possible for him to succeed". So how is destroying myself financially beneficial to my child? Just talking to these people made me feel like I was at an Amway meeting.
Miffed;-)
Miffed, with nearly two years of community college, your daughter has plenty of institutional education. What might be constructive is finding out her real interests and pursue those along the lines of entrepreneurship. I'm 60, and am considering helping out a much younger guy establish his own auto repair shop in exchange for teaching me some basics of auto mechanics. It's a skill that will always be in demand.
I'm not nearly so informed as to what skills women can perform and need most, but almost any trade-oriented skill should provide enough for a start-up business.
Just an example of my thinking: My sister is spending 48K a year to send her 1st daughter to U of Michigan. Imagine investing half that amount in an aspiring new business - even farming or handyman services - instead of throwing it down the education crapper?
I don't have kids, but I'd be sure to steer them more towards trades (my father was a lawyer and my grandfather a mason - my father often lamented that he'd have been better off as a mason) than "professions" wherein you end up a debt slave. Just my opinion.
It's important that a young'un have some attraction to the kind of work they'll be doing for the next 40 years.
Did your daughter take a 'Career Assessment Survey?' They were called Kuder tests in the late 60's.
Mine said I should be a plumber. Things worked out real well for me & the wife.
You're doing the right thing to ignore those banker SHILLS!
Economics is driven by the marginal dollar. MD of QE is negative.
Economics is driven by energy. Which is why we've begun a secular bull market that will last for the next twenty years...
https://www.youtube.com/watch?v=v5RwY1GXAzA&index=30
<-They lie all the time
<-They really slowed the QE
"can the US economy can stand on its own when QE completely winds down?"
The economy can't stand on it's own with QE, let alone without it. The employment participation rate is at 1978 level. Food stamps for nearly 47 million. It is a depression and has been all through out QE.
@Miffed My girlfriends parents saddled her with 100k+ in debt for a degree in urban planning which is like pre-architecture. she not even sure she's gonna go to grad school now becuase she's too deep in debt and it's not what she envisioned when she was 18 years old. I want to punch her parents in the face. At least I got an engineering degree for my 100k thanks to my parents who forced me into something that was worth it.
only 19k left to pay off :( at least half of it is at 2.1%
"Miffed My girlfriends parents saddled her with 100k+ in debt for a degree"
The government made college affordable with government guaranteed loans.
You forgot the sarc/ right ?
Maybe we need to measure the economy not by growth in GDP, which, in and of itself, implies debt, but in sustainable resources and productivity. If every man, woman and child in America could live on his or her own land (think families, a lost cause with >50% children in single-parent homes), grow a substantial portion of their own food and engage in some small "cottage industry" (another relic term), what needs would there be for work for 95% of the population?
The construct we have at present is debilitating to the human spirit. More and more I look at college professors (teachers in general to some degree), lawyers, financial "professionals" and loads and loads of lower, middle and upper management as more drag on the economy than progressive forces. How does one equate $billions in legal fees generated by class actions, civil frauds and such as part of the GDP? The money simply changed hands from one monopoly (corporations) to another (the legal profession). Maybe some of that falls through the cracks down to muppetville, but hardly any.
Rich people today are wondering where to put their money, because there is so much of it sloshing around the upper echelons that it is being crowded out. If one looks at the chart of average GDP during different eras (nice chart porn, BTW), we did best as an industrial nation and, prior to that, as primarily an agricultural nation.
Facebook, instagram, twitter and lots of other internet-related businesses are not real businesses and will produce paltry profits over time. They will be the JC Pennys and Sears of today.
Bottom line, the problem is the Fed and the government, which needs to promote "growth" (inflation) in order to justify their own existences. Do away with fractional reserve banking and miles of government regulation (and the people who write the rules and regulate them), and we'd be way ahead. I'm seriously thinking of running for public office on a radical reform program, but, OTOH, who needs the bother?
The colored vertical bars. Periods of financial fraud. White bars noted by circles. Periods of financial truth.
Financial fraud is the only thing holding the market up.
If the Fed continues tapering, October could be a very interesting month.
How much QE did the FED do in Feb? Look it up and you may be surprised it was not the $65B promised.
or April