Run equity run (with a bit of doping)

It is not the first time in history and will not be the last: the value of equity markets grows in spite of what properly adjusted earnings say. In the United States, it is clear that the Federal Reserve (Fed) liquidity injections and a positive psychological disposition are feeding the markets.

To reach this conclusion it is sufficient to consider that the profits of old corporate America (the S&P 500 companies), adjusted for some extraordinary items (according to the standards of the Federal tax law), have stagnated for years. Companies listed on Nasdaq, the engine of the modern United States, are doing a better but it is clear that the liquidity provided by the Fed lifts share prices more than the fundamentals. In the case of NASDAQ, the weightlifting is mainly done by five stocks (the large tech companies).

Just compare the performance of an equity index, the S&P 500 for example and the Fed balance sheet chart since 2009, immediately after the start of Quantitative Easing (large-scale purchase of bonds): the two curves they go hand in hand.

It is possible to identify, over the approximately ten years analyzed, the points that determined parallelism. Let's see:

1) From the end of 2008, after the bankruptcy of Lehman Brothers, to early 2015, the QE has provided the system, on several occasions, with the necessary liquidity to support the economy and the S&P500 has followed the Fed's purchase program.

2) When QE peaked in early 2015, the stock market stalled and volatility increased.

3) This "reflection phase" continued until the American elections in November 2016 when the new president, Donald Trump, announced a tax reform with an associated cut in corporate taxation, which was then effectively implemented. The effect? A (long but temporary) stock rally which continued until February 2018.

4) Once the tax cut stimulus effect was exhausted, the market entered a new stall phase and volatility began to increase again. Dependence of the S&P 500 on external stimuli is clear: as soon as they stop, growth stops and volatility increases.

5) In mid-September of last year, a problem originating from the very short-term money market (REPO market) required an extraordinary intervention by the Fed: an injection of liquidity similar to that carried out between 2008 and (the peak) in 2015 through QE (so much so that ironically, the intervention was dubbed non-QE). Different terminology, same result: another stock rally.

6) The non-QE stimulus is now over. What will be the consequences?

Volatility is still contained today and markets celebrate the exorcism of the Chinese coronavirus risk practised by the Fed with a (reassuring and dovish) position: if there were signs of a slowdown, it will intervene. The signal that the market was waiting to continue on the bullish path. What to do? Doping is not forbidden here and apparently, nobody cares about the side effects. Probably jogging carefully, paying attention to the heartbeat is the best strategy, looking around for alternative paths.

The chart below illustrates the performance of the S&P 500 and the expansion of the Fed's balance sheet which in fact gives a measure of the liquidity inserted in the system.

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