The Chart Everyone Is Watching [Dow Jones Industrial Average, SPDR S&P 500 ETF Trust]

key level to watchTyler Durden: While it is easy, even sentimental, to pin what may (or may not) be a bubble, or as some call it – market – top on the recent liquidity and euphoria-soaking IPO of China’s mega retailer Alibaba and its sliding chart since it broke for trading, a la what the Blackstone IPO did to the previous bubble, it is also wrong. The reality is that the attention of what few carbon-based investors and traders are left, is glued to very different chart: the one below from Deutsche Bank, showing the  between the S&P and the total assets owned by the Fed.

Read on for the reason why:

 

Less central bank liquidity

In Figure 8 we show what has probably been one of our most used charts of the last year or so. It looks at the relationship between the size of the Fed balance sheet and the S&P 500 (as a proxy for risk generally). As you can see, since the Fed balance sheet was used as an aggressive policy tool post-GFC, the graph suggests that the S&P 500 is well correlated with its size with the former leading the latter by 3 months. For the past 5 years or so the times where we have seen strong performance from risk assets have broadly coincided with periods where the Fed was aggressively expanding its balance sheet. In the periods where the balance sheet wasn’t increasing we generally saw a more challenging environment. So as we have highlighted recently the wobbles seen during the summer months may in part have been due to the imminent end to asset purchases next month (given the 3-month lag in the relationship) and arguably demonstrate the potential challenges facing investors in a world where liquidity is less freely available.

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