2018-05-21

Bear Market or QE4?

I did another detailed look at the Fed's balance sheet versus stock market performance over at Seeking Alpha. Fed Fork In The Road: Bear Market Or QE4

One thing that surprised me is I'd been focused on March 2009 balance sheet expansion and missed the balance sheet reduction in early 2009. The market rebounded into December 2008 and the Fed started easing back some of its support for the market. Even though the Fed committed to expanding its balance sheet in December, the balance sheet shrank at the start and the dip lines up well with the stock market drop. The percent increase in the Fed's balance sheet and the percentage increase in the S&P 500 into 2016 is also too close for comfort.

Correlations often weaken over time and since the Fed balance sheet didn't matter from Nov 2016 to January 2018, it may be that doing nothing was the best option for the Fed. The Fed decided it had to shrink the balance sheet though, and at least since January the correlation has returned. Maybe it'll weaken again as happened from Nov 2016 to January 2018. If it doesn't, the Fed is headed for monthly balance sheet reductions of more than 1 percent of assets. That will translate into a approximately a negative 1 percent monthly headwind for stocks.

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