Where's the Stock Market Headed? Look at the Fed's Balance Sheet!

Fri, Oct 4, 2013 - 3:23pm

What's driven the ups and downs of the stock market over the last few years, you ask? Greg Weldon explains in his recent interview with Financial Sense Newshour that it all comes down to the Fed's balance sheet. To be exact, the two have a correlation (using the S&P 500) of nearly 90%!

Of course, driving the stock market higher doesn't exactly help those that aren't in the stock market; nor does it do anything for the average American's paycheck, as Weldon points out. Since the overwhelming majority of US citizens have very low equity in their homes (if they still have homes) or don't actually own any stocks, the so-called "wealth effect" the Fed has tried to produce has, economically speaking, been a little short on effects. Here we present a few key excerpts from Greg Weldon's recent interview with Jim Puplava airing next Tuesday for subscribers where he puts it all together.

Jim: What’s your macro look on the economy and the markets? Do you think economic activity is starting to pick up in the US?

Greg: When I look at the economy I see pick-up. I see numbers that look fairly robust in some areas, particularly in the housing sector; but when I look at the nominal levels, the percentage gains are exaggerated by the depths from where we are rising—the historical lows—and we are only rising to levels that in the past have been historic lows in previous periods of turbulence. So, we’re only getting back to normal recessionary levels in some of these housing numbers. Thus, it’s difficult to get too excited about that [since] gains in home prices, which again are recovery gains, are not new gains...[plus] that doesn’t put money into people’s pockets every two weeks as a source of new income. Neither does the stock market. So this is an important consideration when we take it to the next level, which is simply this: Without gains in wages, which is just not going to happen when you have chronically unemployed people for long periods of time that don’t count anymore. We all know the demographics around the unemployment report and how poor the labor market is because it’s not generating enough jobs to take down the chronically long-term unemployed. It’s not even creating enough jobs to meet population growth. So, you have a labor force issue, which prohibits any wage gains. Without that, you don’t have your wannabe reflation...but at the same time the liquidity the Fed is pushing in...is really gravitating toward equities specifically. Commodities are not even part of that anymore because we really have learned that this is not a macro-reflation that will generate wages, that will support a rise in the structure of inflation—that is just missing. So what happens is all this money flows straight into equities: equities breakout, managers are behind, no one trusts the rally and then, boom, you have a psychological issue where everyone’s plowing in and, to me, this pretty well defines what we’re seeing right now.

Jim: Are we experiencing a bifurcated economy? People invested in the market have done quite well, but the average American isn’t heavily invested in the market and still faces a lot of pressure on the job and wage front. If, then, the real economy isn’t growing at a strong enough pace while stocks continue to move higher, is there a worry of how long this will continue?

Greg: You have a massive divergence there…can it continue? Absolutely. It can continue while you’re seeing movement out of bonds and into stocks as well. You’ve seen rotation out of safe havens—gold and bonds—and into risk assets—stocks. This is what the Fed has wanted. They are getting exactly what they want. And why is that interesting? Because it’s the only avenue they have so, of course, they are going to protect it…this is the area that they can support the market—they’re going to continue to do that because it’s the only place they’re having any effectiveness in terms of that “feel good factor”. You don’t have it in housing the way you need it, you don’t have it in the labor market at all—you have it in equities. It does create that “feel good factor”—wealth does reflate to those that own equities and, again, that’s a bifurcated polarization of the wealth dynamic that is secular in nature in this nation…at the same time, it’s important to note what I said before and—this is critical—this is not putting money into people’s checking accounts every two weeks like wage inflation would.

So the risk factors out there are still very real and when you see the extension and re-ownership by the public of equities, I think that’s a troubling thought process for down-the-road. Near-term, looks to continue until frankly the Fed pulls the plug.

Jim: Greg, what do you do in a market like this? I think a lot of people have been surprised, as you’ve been talking about, whether you’re looking at housing, which finally began to come off some lows starting last year, you’re looking at an unemployment rate that’s come down because of the participation rate more than anything else, and yet the stock market keeps going up. I think people forget that when the Fed creates money and puts it into the system and artificially suppresses interest rates, they can’t necessarily control where that money will go. So if you were just looking at the economy or looking at the employment rate or looking at wages, which have been stagnant because of the high unemployment rate plus global competition, you would say, “Wow, this really isn’t something I’d want to invest in. This isn’t like the 80s and 90s when the economy was booming.” Yet, money has to find a place and it’s going to go where it’s treated well and if it’s the stock market, it’s going to be the stock market.

Greg: That’s a really great point you just made…there is risk here that the real economy is not peaking in the way the stock market is—this money is going directly into the stock market. One of my favorite charts that we produced is a correlation between the Fed’s balance sheet and the S&P 500, and it is really, really tight. You can see periods where the Fed’s balance sheet goes sideways—those are periods of turbulence and downside action in the US stock market. It’s that simple. Case closed.

If you were expecting the stock market to continue, you would think there’s a lot of opportunity in these beaten down commodities and that’s one of the areas we’re looking at actively right now.

If you would like to hear this full interview with Greg Weldon and Jim Puplava available for subscribers next week, CLICK HERE for more information. In addition to hearing from money managers, institutional investors, and analysts regularly interviewed for FS Insiders, you’ll also gain access to our entire archive of past interviews.

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