One of the most popular charts to post in the financial community is the S&P 500 correlation link with the Fed’s balance sheet, especially since the bull market began in early parts of 2009. Just about every trader, investor, analyst, economist, market “guru” and media anchor quotes it on regular basis. If everyone says it, then it must be true… right? Well, maybe it isn’t.
But what if this relationship stops correlating soon and the Fed loses the control of the stock market? Or maybe it never had the control in the first place? Historically, there is nothing new under the sun (Jesse Livermore quote), so a bull market will stay in a bull market until buyers get exhausted.
Chart 1: Central banks policy & equity prices don’t always correlate
The chart above is broken into three sections. Firstly, Deutsche Bank shows how S&P and Fed’s balance sheet are moving in link since March 2009. Secondly, Ed Yardeni shows how ECB has reduced its balance sheet since mid-2012, while Fed has increased its starting in late 2012. Finally, BCA shows how despite the falling ECB balance sheet, German DAX 30 has moved up a like a rocket. Here are some interesting points to think about:
- So how can one market move up when its local central bank is increasing its balance sheet and yet another market also move up while its local central bank is decreasing its balance sheet?
- Do you remember the correlation charts link to Gold and central banks? That one worked for awhile, but just as everyone was expecting it to work the third time around… it stopped.
- What about the correlation between the Euro and commodities, and in particular Gold? Rising Euro usually meant falling Dollar, so Gold would rally too… however in 2013 as Fed increased its balance sheet and ECB reduced its own, Euro gained against the Dollar while Gold had a worst annual loss since 1981.
It seems to me that certain correlations between central banks and assets work until they don’t, while the majority of the analysts in the industry just guess and make up the reasoning behind the moves. I do not have the answer for all of the questions above, as I do not pay too much attention to what central banks do. I believe in following markets and I believe that assets eventually reflect fundamentals in the long run.