Don’t fight the Fed. As bad as underlying fundamentals ever were, the market over the last nine plus years just never seemed to react. React with staying power, anyway.
Looking back now, the driver of the market’s relentless march upward and investors’ seemingly endless appetite for risk is pretty clear. As it turns out, as long as there is enough money in the system, or, at least, a promise of more money to come, the market can take some pretty big licks right on the chin and keep fighting.
Since 2014, I have had a bit of an obsession with the effect of monetary policy on the performance of U.S. equities. As a result, I’ve been periodically updating some pertinent data of interest. To help clients and colleagues visualize the relationships, I occasionally convert that data into charts. One such chart that has become particularly interesting to me is the comparison between the Federal Reserve’s Total Assets and the Value of the S&P 500. It was touch and go for a while, but I believe that it is now shaping up to tell the story of this market cycle quite nicely.
Without further ado, the chart:
The first thing that I think when I see this chart is that, for better or worse, the Federal Reserve’s monetary policy over the last decade has had an influence on – at the very least – U.S. large cap equities. When you’ve created as many versions of this chart as I have, you also understand that the effects are far wider reaching. It is impossible to deny the nearly lock-step with which equities began to accelerate onward and upward upon the announcement of new monetary intervention, only to languish once the Fed eased off the accelerator.
One glaring example is the performance of the S&P 500 from 11/03/2014 (days after the Fed terminated QE-3) to 11/03/2016 (days before the Presidential Election). Over that two year span, the value of the S&P 500 increased by 3.5%, with an awful lot of turmoil along the way. However, from 9/12/2012 (a day before QE-3 was announced) to 9/12/2014 (a month before the Fed terminated QE-3) the value of the S&P 500 increased by over 38%, with amazingly little volatility. Don’t fight the Fed, indeed!
The second thing that I think when I see this chart is that U.S. large cap equities love stimulus. As they should!
It appears clear from the chart that the only thing that broke the malaise of U.S. big caps post Fed monetary stimulus, was the promise of fiscal stimulus from the newly elected President in November of 2016. Unfortunately, it also appears that the actuality of Federal Reserve balance sheet normalization may be quickly catching up with the hope that fiscal stimulus can keep this long-lived bull market charging into the future.
We have all been given fair warning. The Federal Reserve has made it quite clear that it is its intention to tighten monetary policy. That is, to undo the thing that has sent U.S. large cap equities soaring to all time highs over the last decade. Without some catastrophe preventing it, the Fed will continue to shrink its historically huge balance sheet.
I have looked into it, and have found no comparison for what the Fed is trying to accomplish in trying to reduce the tremendous amount of assets it presently holds. Honestly though, if the effect that the accumulation of those assets had on markets is any indication, I am not terribly confident that the Fed will get very far in its asset disposal before the market begins to react just as quickly and violently to the downside as it did to the upside.
For the moment, this chart looks like a train decelerating. I just wonder how long it will be before it resembles a train wreck.
Don’t fight the Fed.