Overlaid on the S&P 500 is the Federal Reserve’s balance sheet size (scale on the right), which reflects the massive purchases of Treasuries and Mortgage Backed Securities through their quantitative easing programs.

The high correlation between the trend of the Fed’s balance sheet and the S&P 500 is obvious. Liquidity has been the mother’s milk of this bull cycle. When the rate of growth of their balance sheet has fallen to zero, market corrections have occurred. Consider the following:

  • One month following the termination of QE1 in April 2010, the equity markets experienced the “Flash Crash.”
  • The month following the end of QE2 in June 2011, we experienced the sharp 20% correction in July 2011.

Ostensibly, the Feds “tapering” program is meant to avoid these sudden market disruptions. In their June policy meeting, the end of this QE program was set for October 2014. Until then, the Fed’s balance sheet continues to grow and we anticipate that the markets will continue to advance.

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