S&P 500: Betting on QE

The S&P 500 continued its cautious advance in a shortened week due to Thanksgiving. Expect retracement to test the new support level at 3000.

S&P 500

I believe that the latest surge has little do with an improved earnings outlook and is simply a straight bet that Fed balance sheet expansion (QE) will goose stock prices in the short- to medium-term. The chart below highlights the timing of the increase in Fed assets and its effect on the S&P 500 index.

S&P 500 and Fed Total Assets

There is plenty of research on the web pointing to a strong correlation between QE and equity prices. Here are two of the better ones:

Economic Activity

If we look at fundamentals, many of them are headed in the opposite direction.

Bellwether transport stock Fedex (FDX) is testing primary support at 150. Breach would warn of a slow-down in economic activity.


Monthly container traffic at the Port of Los Angeles shows a marked year-on-year fall in imports and, to a lesser extent, exports.

Port of Los Angeles: Container Imports & Exports

Rather than boosting local manufacturers, industrial production is falling.

Industrial Production

Production of durable consumer goods is falling even faster, though the October figure may be distorted by the GM strike.

Industrial Production: Durable Consumer Goods

What is clear is that slowing growth in the global economy is unlikely to reverse any time soon.

Market Cap v. Corporate Profits

Yet market capitalization for non-financial stocks is at a precarious 24.7 times profits before tax, second only to the Dotcom bubble. The surge since 2010 coincides with Fed injection of a net $2.0 trillion into financial markets ($4.5T – $2.5T in excess reserves).

Nonfinancial corporations: Market Capitalisation/Profits before tax

The problem, as the Fed unwind showed, is that once central banks embark on this path, it is difficult for them to stop. The Bank of Japan started in the late 1980s — and is still at it.

Bank of Japan: Total Assets

Margin Debt

This chart from Advisor Perspectives compares the S&P 500 to margin debt. The decline since late 2018 appears ominous but November margin debt levels may reflect an up-turn. We will have to keep a weather eye on this.

FINRA Margin Debt & S&P 500 Index


Patience is required. First, wait for S&P 500 retracement to confirm the breakout. Second, look for an up-turn in November economic indicators, especially employment, to support the bull signal. Failure of economic indicators to confirm the breakout will flag that market risk is elevated and investors should exercise caution.

“If the mind is to emerge unscathed from this relentless struggle with the unforeseen, two qualities are indispensable: first, an intellect that, even in the darkest hour, retains some glimmerings of the inner light which leads to truth; and second, the courage to follow this faint light wherever it may lead.”
~ Carl Von Clausewitz, Vom Kriege (On War) (1780-1831)

What is contributing to the surge in US corporate profits?

Some concern has been expressed in the media about the rising level of margin debt in the US. When expressed as a percentage of GDP, NYSE margin debt is approaching 1999/2007 levels.

NYSE Margin Debt as percentage of GDP

But not only margin debt is rising. Market capitalization, while not as fast, is also on the increase.

NYSE Market Cap as percentage of GDP

And market cap merely reflects the underlying rise in corporate profits, measured here as a percentage of GDP.

Corporate Profits as percentage of GDP

My initial reaction was to attribute the rise to increasing globalization of US corporations, but Rebecca Wilder points out that earnings from abroad have scarcely grown. Closer scrutiny of the Bureau of Economic Analysis Q1 2013 release shows Manufacturing is the top growth sector.

So what is contributing to the surge in corporate profits?

Employee compensation has declined as a percentage of net value added by the corporate sector over the last decade.

Corporate Profits as percentage of GDP

And there has been a sharp rise in petroleum and coal output, reflected by producers’ annual value shipped ($billion) in the graph below.

Petroleum and Coal shipments

Also, the percentage of corporate profits paid as taxes is shrinking. The following graph compares corporate profits after tax to corporate profits before tax. Less than 20 percent of corporate profits is currently being paid in taxes.

Corporate Profits as percentage of GDP

Are these ratios sustainable?

While unemployment remains high, growth in employee compensation is expected to be low. And corporate taxes are likely to remain low until there is a major overhaul of the tax code (don’t hold your breath). So market capitalization is likely to remain strong for at least the next two to three years.


Australian margin debt is declining steeply as a percentage of GDP.

ASX Margin Debt to GDP

ASX market capitalisation as a percentage of GDP is also trending lower. The 2009/2012 lows should provide a sound base for further gains.

ASX Market Cap to GDP

The ASX is muted compared to US markets, but offers value in the long-term.

Expanding debt: Dousing the flames with gasoline

We are now in the fifth year of recovery from the worst financial crisis in 50 years — fueled by expanding household debt, rising from 50% of GDP in the 1980s to close to 100% in 2008. Contraction since the GFC has brought US household debt back to 80% of GDP…

Household Debt as % of GDP

But a worrying sign is that consumer debt has started to rise
Consumer Debt as a % of Disposable Income

And Steve Keen points out that margin debt is also rising, fueling the latest stock market rally.

Yahoo: Steve Keen Interview
[click on the image to view the video in a separate window]

Holding interest rates at artificially low levels for an extended period risks fueling another credit bubble. The Fed/central bank needs to react quickly to expanding credit in any area of the economy. We all hope for a recovery, but it must be sustainable — with consumption fueled by rising employment rather than rising debt — and not another debt-fueled boom-then-bust.