Saturday, June 23, 2012

Tony Caldaro on the FED's Liquidity Programs & the Stock Market


Fundamentally, the markets have been in a FED driven liquidity cycle since late 2008. When the Treasury Department started the $800 bln TARP program in October 2008, the FED initated QE1 at $200 bln. Clearly neither were enough to offset the deflationary pressures as the market made new lows into March 2009. Then on March 10th 2009 the FED expanded the QE1 program to $1.4 tln until June 2010. The stock market soared, rallying from a Mar09 low of SPX 667 to SPX 1220 by Apr10. Anticipating the end of QE1 the stock market began to correct. When the FED failed to extend QE1, or introduce a new program at their June meeting, the market made lower lows into July. From that low at SPX 1011 another rally began. 

Then on August 27th the FED introduced QE2 at $600 bln until June 2011. The market soared again, hitting SPX 1371 by May 2011. And again, it began to correct in anticipation of QE2 ending. When the FED failed to introduce another liquidity program, and troubles in Europe widened, the correction steepened. While the stock market was going through this 22% correction the FED introduced a $400 bln Operation Twist on September 21st until June 2012. The market was disappointed and continued lower. In October 2011 the EU introduced a $1 tln EFSF program, similar to TARP. The market then bottomed at SPX 1075 and started to rally. The ECB then introducted LTRO 2 in December and the market   continued to rally. In March 2012, anticipating the end of Op Twist in June, the market hit SPX 1422 and began to correct. This month the market hit a low of SPX 1267, then rallied for two weeks ahead of last week’s FOMC meeting. After the meeting the FED expanded Op Twist from $400 to $667 bln until December 2012. The stock market quickly sold off the following day. This is a summary of the liquidity cycle and its effects on the stock market over the past four years.

If one examines the liquidity programs and their results they will discover a pattern. We are fairly certain the FED has as well. When the FED expanded QE1 to $1.4 tln the market closed that day at SPX 720. Before the program ended the SPX hit 1220, for a gain of 69%. When the FED introduced QE2 at $600 bln the market closed that day at SPX 1065. Before that program ended the SPX hit 1371, for a gain of 29%. Then when the FED introduced Op Twist for $400 bln the market closed that day at SPX 1167. The market was initially disappointed as it made a lower low. However before the program was recently expanded the SPX had hit 1422, for a gain of 22%. When the FED expanded the program this week by an odd $267 bln we figured they too had discovered the pattern.

For every $20 bln the FED purchases in long term debt the stock market rises 1%
  • QE1 was $1.4 tln: expected rise 70%, actual rise 69%. 
  • QE2 was $600 bln: expected rise 30%, actual rise 29%. 
  • Op Twist was $400 bln: expected rise 20%, actual rise 22%. 
  • Op Twist expanded to $667 bln: expected overall rise 33%, actual rise yet to be determined. 

In summary, when the FED introduced Op Twist for $400 bln they were expecting the market to rise 20%. Despite the decline after the introduction at SPX 1167, the market rose 22% to SPX 1422. 

Now, with the expansion of the program to $667 bln they are likely expecting an overall rise of 33.3% from the time the program was first introduced. Or, a rise of 13.3 % from the time it was extended. A 33.3% rise from SPX 1167 equals SPX 1556. A 13.3% rise from SPX 1356 equals SPX 1536. The all time high for the SPX is 1576. Mission almost accomplished!