The expanding-multiple-dependent US equity market that we have discussed numerous times (most recently here [4]) appears to have hit a snag. While we noted the almost perfect correlation between forward-looking P/Es and the market during the last three years - and the clear hope-iness nature of said multiple expansion (and reality contraction) - what we failed to note until now is the significantly diminishing multiple-expansion impact from each of the Fed's actions. QE1 created a plus-4x multiple expansion (from ~10 to ~14), QE2 created a plus 1.5x pop in multiples, and Operation Twist around the same. Critically though, as soon as the Fed-sponsored money-supply 'flow' expansion ended, so the P/E multiple-expansion ended (and indeed reversed very quickly). It really is about the flow [5]; and the threat of a crack-addicted market's requirement for perpetual QE.
[6]
So critically, unless we see/hear believe that the Fed will embark on perpetual and exponentially growing QE since its impact is lesser and lesser, then its game over for the equity market - and if they 'hint' at open-ended easing than Gold goes sky-bound...
Chart: Morgan Stanley