A Useful Leading Indicator?

We often see charts comparing the S&P 500 to the growth in the Federal Reserve’s balance sheet, or more specifically, to assets held by the Fed. There is undeniably a close correlation between the two, but it has struck us as not very useful as a “timing device”, or an early warning device if you will.

Recently we have come across a video of a presentation by Bob Murphy, in which he uses a slightly different comparison that might prove more useful in this respect. Instead of merely looking at Fed assets, he uses the total monetary base. Here is a chart comparing the monetary base to the S&P 500 Index since 2009:

 

1-Monetary Base vs SPXThe monetary base (red line) vs. the S&P 500 (blue line) – as can be seen, sometimes one or the other series leads, but in recent years the monetary base has been a leading indicator. It probably lagged the market in 2010/11 due to the fact that traders at the time bought stocks in anticipation of more monetary pumping – whereas nowadays the market appears to be reacting with a slight lag to changes in base money – click to enlarge.

 

Below is a chart that shows consolidated assets held by the Federal Reserve system for comparison. Since the Fed is currently reinvesting funds from MBS and treasuries that mature, its total asset base is basically flat-lining since the end of QE3. Obviously, all that can be gleaned from this fact is that the central bank is currently not actively pumping up the money supply. Currently money supply growth is therefore largely the result of commercial bank credit growth.

 

2-Fed AssetsAssets held by the Federal Reserve – flat-lining since the end of QE3. Interesting, but not useful as a short term leading indicator of the stock market – click to enlarge.

 

A Different Regime

The post 2008 monetary regime differs from the previous state of affairs due to the vast growth in central bank balance sheets and the associated growth in bank reserves. This has created a technical problem for central banks if they want to tighten monetary policy, as the Fed is planning to do.

In times past the Fed would either add or withdraw liquidity from the system by means of asset purchases, resp. sales, both of the temporary and occasionally the permanent variety (i.e., via repos and coupon passes), so as to keep the effective Fed Funds rate on target. It can no longer do this if it wants to keep the stock of assets it holds unchanged. Since selling off enough assets to return to the previous regime would collapse the money supply, it isn’t going to happen.

The Fed is primarily keeping control over the FF rate target by paying interest on bank reserves. This keeps the currently almost non-existent interbank lending market in catatonia, since there is no point in lending out excess reserves for less than one can get safely from the Fed. However, ever larger short term reverse repo operations are undertaken as well (we have previously discussed the vast surge in these transactions at year-end).

These reverse repos usually swell near month-end and especially near the end of a quarter. This seems to serve various purposes. Among these is apparently the desire to relieve collateral shortages/ delivery fails (which have increased due to QE removing a great many securities from the marketplace), but the Fed is presumably also employing these reverse repos as another way of exerting control over short term interest rates.

While the amount of assets held by the Fed doesn’t change on account of such operations (since the assets are only lent out, but continue to belong to the Fed), it seems the effect is reflected in monetary base statistics. This is illustrated by the chart below, which compares outstanding reverse repos to the monetary base. Spikes in reverse repos align quite closely with short term declines in the monetary base, even if the correlation is not perfect (as these are not the only factors influencing the base).

 

3-Monetary Base vs ReposThe monetary base vs. Fed reverse repos outstanding – click to enlarge.

 

Demand for Stocks Declines Around Quarter-End

One thing is clear: during the brief time periods when large reverse repo operations are undertaken, liquidity in the system temporarily decreases. The lead-lag relationship between the monetary base and the S&P 500 shown in the first chart seems to suggest that this does have an impact on the stock market.

How big an influence it really represents is however not certain, as there is another important reason why the demand for stocks tends to decline around the end of the quarter. As has recently been discussed at Bloomberg,  earnings season begins at the time as well, which forces companies to suspend stock buybacks for a few weeks.

Given the enormous size of buybacks in recent years (another new record high will likely be achieved this quarter), it is probably no surprise that the period during which buybacks are suspended also aligns closely with market weakness of late. Here is a chart derived from a Goldman Sachs research report illustrating this point:

 

4-buyback pauseStocks have been especially weak last quarter around the peak of the earnings season – click to enlarge.

 

According to GS analyst David Kostin, the influence of the “blackout period” is especially large at the moment, as other important groups of potential buyers are currently out of the picture:

 

“Corporate buybacks are the sole demand for corporate equities in this market,” David Kostin, the chief U.S. equity strategist at Goldman Sachs Group Inc., said in a Feb. 23 Bloomberg Television interview. “It’s been a very challenging market this year in terms of some of the macro rotations, concerns about China and oil, which have encouraged fund managers to reduce their exposure.”

[…]

Kostin said companies tend to enact a blackout period and restrict share repurchases in the month following the end of a calendar quarter, and come back once they’ve reported results. In a market where everyone else is selling, the ebb and flow of corporate actions have amplified volatility.”

 

We’re not so sure that corporate buybacks are the “sole demand for equities”, but it is probably true that buybacks or the lack thereof have more effect on short term volatility in times when other market participants are uncertain and less inclined to buy.

 

Conclusion

Regardless of which source ultimately proves more important, the above suggests that market liquidity tends to become more scarce around the end of the quarter at present. We have already seen this effect play out twice in row and it could well be that there will be another replay this quarter.

Considering what happened in 2010, much also depends on perceptions about upcoming Fed policy, but it seems unlikely that today’s FOMC statement will do much to alter expectations. We can take the buyback blackout period as a given, which leaves us with watching the monetary base for clues.

It will be interesting to see whether the next decline in the monetary base – which should be expected to occur around quarter-end based on previous observations – will once again precipitate stock market weakness. It is definitely possible that this indicator is useful for short term trading purposes – at least for the time being.

Stay tuned for a more general look at developments in the US monetary backdrop to be posted shortly.

 

Charts by St. Louis Federal Reserve Research, Bloomberg

 

 
 

Emigrate While You Can... Learn More

 
 

 
 

Dear Readers!

You may have noticed that our so-called “semiannual” funding drive, which started sometime in the summer if memory serves, has seamlessly segued into the winter. In fact, the year is almost over! We assure you this is not merely evidence of our chutzpa; rather, it is indicative of the fact that ad income still needs to be supplemented in order to support upkeep of the site. Naturally, the traditional benefits that can be spontaneously triggered by donations to this site remain operative regardless of the season - ranging from a boost to general well-being/happiness (inter alia featuring improved sleep & appetite), children including you in their songs, up to the likely allotment of privileges in the afterlife, etc., etc., but the Christmas season is probably an especially propitious time to cross our palms with silver. A special thank you to all readers who have already chipped in, your generosity is greatly appreciated. Regardless of that, we are honored by everybody's readership and hope we have managed to add a little value to your life.

   

Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke

   
 

One Response to “The Monetary Base, Buybacks and the Stock Market”

Your comment:

You must be logged in to post a comment.

Most read in the last 20 days:

  • Gold Sector: Positioning and Sentiment
      A Case of Botched Timing, But... When last we wrote about the gold sector in mid February, we discussed historical patterns in the HUI following breaches of its 200-day moving average from below. Given that we expected such a breach to occur relatively soon, the post turned out to be rather ill-timed. Luckily we always advise readers that we are not exactly Nostradamus (occasionally our timing is a bit better). Below is a chart of the HUI Index depicting the action since the January...
  • India: The next Pakistan?
      India’s Rapid Degradation This is Part XI of a series of articles (the most recent of which is linked here) in which I have provided regular updates on what started as the demonetization of 86% of India's currency. The story of demonetization and the ensuing developments were merely a vehicle for me to explore Indian institutions, culture and society.   The Modimobile is making the rounds amid a flower shower. [PT] Photo credit: PTI Photo   Tribal cultures face...
  • The Long Run Economics of Debt Based Stimulus
      Onward vs. Upward Something both unwanted and unexpected has tormented western economies in the 21st century.  Gross domestic product (GDP) has moderated onward while government debt has spiked upward.  Orthodox economists continue to be flummoxed by what has transpired.   What happened to the miracle? The Keynesian wet dream of an unfettered fiat debt money system has been realized, and debt has been duly expanded at every opportunity.  Although the fat lady has so far only...
  • March to Default
      Style Over Substance “May you live in interesting times,” says the ancient Chinese curse.  No doubt about it, we live in interesting times.  Hardly a day goes by that we’re not aghast and astounded by a series of grotesque caricatures of the world as at devolves towards vulgarity. Just this week, for instance, U.S. Representative Maxine Waters tweeted, “Get ready for impeachment.”   Well, Maxine Waters is obviously right – impeaching the president is an urgent...
  • Welcome to Totalitarian America, President Trump!
      Trump vs. the Deep State If there had been any doubt that the land of the free and home of the brave is now a totalitarian society, the revelations that its Chief Executive Officer has been spied upon while campaigning for that office and during his brief tenure as president should now be allayed.   Image adapted from the cover of “Deep State #5” - depicting an assassin from the future   President Trump joins the very crowded list of opponents of the American...
  • Searching for Truth
      Heresy or Truth? RANCHO SANTANA, NICARAGUA – In the fifth century, Christian scholars counted 88 different heresies. Arianism. Eutychianism. Nestorianism. If there was a way to “offend” God, they had a name for it. One group of “heretics” argued that there was no such thing as “original sin.” Another denied the trinity. And another claimed Jesus was not divine. Which one had the truth?   Depiction of the first Council of Ephesus in 431 AD, convened by Emperor...
  • Why the 21st Century Sucks - Turtles All the Way Down
      A Truly Sucky Century BALTIMORE – What an awful century! Worst we’ve ever seen. Household incomes are down. Employment is down, with 7 million people in the U.S. of working age without jobs. Productivity growth is down. GDP growth is down – to only about 0.5% per capita last year. Even life expectancies are down. Drug overdoses are up. Suicides are up. One out of every eight children lives in a family getting food stamps. One of out every eight adults takes psychoactive drugs...
  • Gold and the Fed's Looming Rate Hike in March
      Long Term Technical Backdrop Constructive After a challenging Q4 in 2016 in the context of rising bond yields and a stronger US dollar, gold seems to be getting its shine back in Q1. The technical picture is beginning to look a little more constructive and the “reflation trade”, spurred on further by expectations of higher infrastructure spending and tax cuts in the US, has thus far also benefited gold. From a technical perspective, there are indications that the low at $1045.40,...
  • The Unstable Empire – A Campfire Tale
      Campfire Tale   Caesar: The Ides of March are come. Soothsayer: Ay, Caesar, but not gone. — Julius Caesar, Shakespeare   GRANADA, NICARAGUA – Today, we stop the horses and circle the wagons. For 19 years, we have been rolling along, exploring, discovering. We began with the assumption that we didn’t “know” anything - so we kept our eyes open. Now we know even less.   Famous people who knew nothing and were not shy to admit it: Sergeant Schultz...
  • Off the Beaten Path in Mesoamerica
      Greeted by Rooster There’s an endearing quality to a steadfast rooster call at the crack of dawn when overheard from a warm country farmhouse.  There’s a reassuring charm that comes with the committed gallinaceous greeting of daybreak that’s particularly suited to a rural ambiance.  The allure of a morning cock-a-doodle-doo somehow falls flat in all other settings.   Good morning everyone! Before meteorological forecasts were available on TV and smart phones, people...
  • Why Silver Went Down – Precious Metals Supply and Demand
      Rumor-Mongering vs. Data The question on the lips of everyone who plans to exchange his metal for dollars—widely thought to be money—is why did silver go down? The price of silver in dollar terms dropped from about 18 bucks to about 17, or about 5 percent.   Reportedly silver was already assassinated in the late 19th century... so last week they must have assassinated its corpse. [PT] Illustration taken from 'Coin's Financial School'   The facile answer is...
  • Systematic Trading - Unwrapping the Onion
      Lumpy but Robust   [ed note: this article has originally appeared at the Evil Speculator and was written by trader and ES contributor Scott. We provide a link to Scott's past articles below this post for readers who want to get more familiar with his ideas and/or any unusual terminology used in this article]   One continual theme in my trading is that every time I think I have it figured out, I get punched in the face by an unexpected problem. The tendency is to go more...

Austrian Theory and Investment

Support Acting Man

Own physical gold and silver outside a bank

Archive

j9TJzzN

350x200

Realtime Charts

 

Gold in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Gold in EUR:

[Most Recent Quotes from www.kitco.com]

 


 

Silver in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Platinum in USD:

[Most Recent Quotes from www.kitco.com]

 


 

USD - Index:

[Most Recent USD from www.kitco.com]

 

THE GOLD CARTEL: Government Intervention on Gold, the Mega Bubble in Paper and What This Means for Your Future

 
Buy Silver Now!
 
Buy Gold Now!
 

Oilprice.com