Back in 2010 we were the first to show that the only thing that matters for centrally-planned, Fed (and HFT)-manipulated markets is the size of the Fed’s balance sheet and the only financial statement of any macro relevance is the Fed’s weekly H.4.1 release.
Initially mocked (but… but… the fundamentals), the subsequent proliferation of charts showing the correlation between the Fed’s balance sheet and the S&P 500, has confirmed that virtually everyone – even the Treasury itself – has agreed that the only marginal driving force for the world’s largest stock market – i.e. the catalyst for the biggest artificial bull market rally in recent history – is the Federal Reserve, specifically the amount of debt monetized/liquidity injected.
And then that chart slowly disappeared from view for the simple reason that for all of 2013, the Fed’s balance sheet would grow by an equal $85 billion per month in linear “bottom left to upper right” fashion, resulting in an S&P500 that tracked this balance sheet growth tick for tick.
It is time to revisit this chart because as Deutsche Bank’s Jim Reid reminds us, the days of relentless Fed balance sheet, and thus S&P, growth are over, thus the need by Deutsche Bank to “raise the warning flag.”
The risk sell-off we’ve seen in recent weeks frustrates us a little as the chart we’ve published most this year has pretty much predicted that tougher times would come around July. We’ve been paying it a lot of attention for over a year now but decided to wait until the autumn before we raised the warning flags. The chart in question (included in today’s pdf) is the one showing the Fed balance sheet and the S&P 500 (as a proxy for risk generally). As you can see, since the Fed balance sheet was used as an aggressive policy tool post-GFC, the graph suggests that the S&P 500 is well correlated with the size of the Fed balance sheet with the former leading the latter by 3 months. Given that the Fed have recently signalled that they will likely be finishing expanding their balance sheet in October, 3 months before that was July. This is important as virtually all of the mega rally in the last 5 years has come in the Fed balance sheet expansion periods. The other periods have been more challenging for markets.
In other words, the growth is over. As for the downside, well that’s where the Fed’s tightening rate hikes come into play, and once the market has determined the date when the Yellen Fed begins fighting “noisy” inflation and “lack of labor slack”, watch as the entire stock market is sold off in calm, cool and orderly fashion. Just like high yield debt…