New Week, New Month, Same Old Story

Articles From: Interactive Brokers
Website: Interactive Brokers

By:

Chief Strategist

Interactive Brokers

It’s a summer Monday and the start of a new month.  Stocks followed a typical script, rising early because, well…, um…, just because. 

To be fair, it is not unusual to see futures trade higher on the first trading day of a new month.  There is a persistent belief that new money flows into the markets on that day from 401K’s and the like, so of course traders bid up index futures to try to get ahead of those flows.  Bear that in mind when you wake up and see futures higher on the first of the month on no specific news. 

Of course, that theory covers the first day of the month, not the other 20 trading days a month when we are seemingly as likely to see futures trading higher on no particular news.  I know it is simplistic to say that markets seemingly go up because they go up, but here is a chart that goes a long way to explaining the key relationship behind the steadily rising stock market:

Year-to-Date Federal Reserve Balance Sheet (white) vs. S&P 500 (SPX, blue)

Year-to-Date Federal Reserve Balance Sheet (white) vs. S&P 500 (SPX, blue)

Source: Bloomberg

I’m not usually a fan of simply putting a chart with two lines that seem to move together unless there is a valid reason to suspect causality.  In this case, I think the causality is incredibly clear.  The Federal Reserve has been steadily increasing their balance sheet, which is a reflection of the monetary stimulus that they have been providing since March, 2020.  Since the last market hiccup last September, the balance sheet and SPX have been in lockstep.  Consider these statistics:

SPX vs Fed Balance Sheet Linear Regression Since October, 2020 (top) with Statistics (below)

SPX vs Fed Balance Sheet Linear Regression Since October, 2020
SPX vs Fed Balance Sheet Linear Regression Since October, 2020 with Statistics

Source: Bloomberg

This is a stunning regression and correlation.  We might have guessed from the first graph that they would show a nearly perfect linear relationship and high correlation, but an R-squared of 0.919 is quite high.  The only quibble is that there are only 43 weekly observations in that set, but I contend that there is a clear cause-effect behind the statistics.

Can there be reasons for this relationship to break?  Of course.  Equity markets discount future events, at least in theory, so economic releases that offer reasons for the Fed to reduce the pace of its stimulus could cause stocks to react before the Fed actually moves.  Also, we quietly reached the federal debt ceiling.  While few expect that the US will actually default in the coming weeks, a delay in approving a debt ceiling expansion could lead to impediments to the Fed’s normal purchases of government securities.  Also, the end of eviction and student loan moratoria could cause outflows from stocks as investors who had delayed paying some of their obligations now use equity holdings to pay down debt. 

For now though, it’s the same old same old.  And that tends to be a plus for most investors.

Disclosure: Interactive Brokers

The analysis in this material is provided for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IBKR to buy, sell or hold such investments. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Interactive Brokers, its affiliates, or its employees.

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