Fed Tightened QE: Near Term Market Risk

| About: SPDR Dow (DIA)
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Summary

We've been watching Fed reserve balances.

They went down last week more than they have since 2012.

That has typically coincided with down markets.

We expect near term market risk.

We have been following Federal Reserve balances for months. We think it is probably the most important metric in the world today. While most central banks are easing at extreme levels, the Fed has been trying to tighten. With the markets up they may have picked their spot to start. We think this is a meaningful near term risk to the market (NYSEARCA:SPY).

Let's look at the Fed balances.

Date Amount Week Chg YTD Chg SPY YTD
2016-06-22 4228829713320.6 0.17% 0.08% 0.77%
2016-06-29 4213862766793.10 -0.35% -0.27% -0.69%
2016-07-06 4213862766644.23 0.00% -0.27% 1.45%
2016-07-13 4213862766647.87 0.00% -0.27% 2.51%
2016-07-20 4225546202408.16 0.28% 0.00% 1.47%
2016-07-27 4209382864330.18 -0.38% -0.38% 6.50%

This week's decline of .38% was the greatest since late 2012. This has usually coincided with down markets.

The Fed's massive liquidity spree has held markets up. We've been worried for some time that when the Fed reserve balances come back down in the Fed's plan for "normalization" the markets will come down with it.

Let's see the chart of Fed reserve balances to show that the weekly decline is not only the biggest week-to-week but it also takes the reserves below any time in the last year. We think that should coincide with a lower market.

Here's the Fed balance levels.

Here you can see above (yellow line) the Federal Reserve balances have started to come down. We don't know if this is the medium term direction but the level is the lowest in over a year. That has coincided with the stock market.

Here is the annual change in Fed balances versus the market. When this yellow line changes the market changes almost in lockstep.

Year Total YoY Change S&P 500
2004-12-29 715507486000.0 0.02% 7.33% 10.88%
2005-12-28 740848599000.0 0.00% 3.49% 4.91%
2006-12-27 774987618000.0 0.17% 4.51% 15.79%
2007-12-26 749750234000.0 -1.98% -3.28% 5.49%
2008-12-31 489693502900.0 -0.24% -41.64% -37.00%
2009-12-30 1838849745975.6 -0.12% 139.39% 26.46%
2010-12-29 2149525358436.2 -0.34% 15.79% 15.06%
2011-12-28 2603764526266.3 -1.04% 19.29% 2.11%
2012-12-26 2649332839120.3 -0.42% 1.80% 16.00%
2013-12-31 3742632690427.8 -0.18% 34.77% 32.39%
2014-12-31 4220690108476.8 -0.25% 12.06% 12.32%
2016-07-27 4209382864330.18 -0.38% -0.38% 6.50%

You can see above that the change in Fed reserve balances almost precisely related to stock market moves.

We think Fed balances move markets because the amount is too big for the market to trade "free."

Therefore each wiggle of that yellow line wiggles the markets. (We proved that with three charts here.)

Now we'll show how weekly changes in Fed balances directly have led to stock market moves.

On the right side we show Fed balances re-priced to match the level of SPYs along with the week-to-week changes. On the left side you see the SPY price and the week-to-week changes. The right side (Fed) leads the left side (S&P 500).

1/12/2015 201.63 -1.3% 208.25 0.4%
1/20/2015 204.97 1.7% 208.14 -0.1%
1/26/2015 199.45 -2.7% 207.55 -0.3%
2/2/2015 205.55 3.1% 207.55 0.0%
2/9/2015 209.78 2.1% 207.52 0.0%
2/17/2015 211.24 0.7% 208.03 0.2%
2/23/2015 210.66 -0.3% 207.59 -0.2%
3/2/2015 207.50 -1.5% 207.60 0.0%
3/9/2015 205.83 -0.8% 207.60 0.0%
3/16/2015 210.41 2.2% 207.88 0.1%
3/23/2015 205.74 -2.2% 207.19 -0.3%
3/30/2015 206.44 0.3% 207.19 0.0%
4/6/2015 210.04 1.7% 207.19 0.0%
4/13/2015 207.95 -1.0% 207.26 0.0%
4/20/2015 211.65 1.8% 207.39 0.1%
4/27/2015 210.72 -0.4% 206.50 -0.4%
5/4/2015 211.62 0.4% 206.50 0.0%
5/11/2015 212.44 0.4% 207.72 0.6%
5/18/2015 212.99 0.3% 207.41 -0.2%
5/26/2015 211.14 -0.9% 206.67 -0.4%
6/1/2015 209.77 -0.6% 206.67 0.0%
6/8/2015 210.01 0.1% 206.67 0.0%
6/15/2015 210.81 0.4% 207.58 0.4%
6/22/2015 209.82 -0.5% 207.85 0.1%
6/29/2015 207.32 -1.2% 207.15 -0.3%
7/6/2015 207.48 0.1% 207.15 0.0%
7/13/2015 212.47 2.4% 207.72 0.3%
7/20/2015 208.00 -2.1% 207.96 0.1%
7/27/2015 210.50 1.2% 207.24 -0.3%
8/3/2015 207.95 -1.2% 207.24 0.0%
8/10/2015 209.42 0.7% 207.24 0.0%
8/17/2015 197.83 -5.5% 207.89 0.3%
8/24/2015 199.28 0.7% 207.33 -0.3%
8/31/2015 192.59 -3.4% 207.33 0.0%
9/8/2015 196.74 2.2% 207.33 0.0%
9/14/2015 195.45 -0.7% 207.75 0.2%
9/21/2015 192.87 -1.3% 208.12 0.2%
9/28/2015 195.00 1.1% 207.56 -0.3%
10/5/2015 201.33 3.2% 207.56 0.0%
10/12/2015 203.27 1.0% 208.31 0.4%
10/19/2015 207.51 2.1% 208.20 -0.1%
10/26/2015 207.93 0.2% 207.65 -0.3%
11/2/2015 210.04 1.0% 207.65 0.0%
11/9/2015 202.54 -3.6% 207.65 0.0%
11/16/2015 209.31 3.3% 208.05 0.2%
11/23/2015 209.56 0.1% 207.63 -0.2%
11/30/2015 209.62 0.0% 207.63 0.0%
12/7/2015 201.88 -3.7% 207.63 0.0%
12/14/2015 200.02 -0.9% 208.04 0.2%
12/21/2015 205.68 2.8% 208.26 0.1%
12/28/2015 203.87 -0.9% 207.76 -0.2%
1/4/2016 191.92 -5.9% 207.76 0.0%
1/11/2016 187.81 -2.1% 208.40 0.3%
1/19/2016 190.52 1.4% 207.82 -0.3%
1/25/2016 193.72 1.7% 207.52 -0.1%
2/1/2016 187.95 -3.0% 207.52 0.0%
2/8/2016 186.63 -0.7% 207.52 0.0%
2/16/2016 192.00 2.9% 208.14 0.3%
2/22/2016 195.09 1.6% 208.35 0.1%
2/29/2016 200.43 2.7% 207.90 -0.2%
3/7/2016 202.76 1.2% 207.90 0.0%
3/14/2016 204.38 0.8% 208.11 0.1%
3/21/2016 203.12 -0.6% 208.35 0.1%
3/28/2016 206.92 1.9% 207.86 -0.2%
4/4/2016 204.50 -1.2% 207.86 0.0%
4/11/2016 207.78 1.6% 208.50 0.3%
4/18/2016 208.97 0.6% 208.08 -0.2%
4/25/2016 206.33 -1.3% 207.35 -0.3%
5/2/2016 205.72 -0.3% 207.35 0.0%
5/9/2016 204.76 -0.5% 207.35 0.0%
5/16/2016 205.49 0.4% 207.74 0.2%
5/23/2016 210.24 2.3% 207.16 -0.3%
5/31/2016 210.28 0.0% 207.16 0.0%
6/6/2016 210.07 -0.1% 207.16 0.0%
6/13/2016 206.52 -1.7% 207.56 0.2%
2016-06-22 208.10 0.8% 207.92 0.2%
2016-06-29 206.66 -0.7% 207.18 -0.4%
2016-07-06 209.66 1.5% 207.18 0.0%
2016-07-13 214.92 2.5% 207.18 0.0%
2016-07-20 218.09 1.5% 207.76 0.3%
2016-07-27 216.52 -0.7% 206.96 -0.4%

Above you see that most of the times that the Fed dropped their reserve levels the market dropped soon after.

This drop in reserves, we'd remind you, is the biggest weekly drop since 2012. So we'd expect this to coincide with near term market risk.

Please be safe.

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Disclosure: I am/we are short SPY.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.