I have been pretty rough on the market over the last couple of days (see here and here) as to why the markets are unlikely to repeat the secular bull market of the 80’s and 90’s anytime soon. However, as I have stated repeatedly over the last several months, such comments do not mean that the markets can not go higher in the near term. We are reminded of this fact in a recent note from Bespoke Investment Group which discussed the impact of the FOMC’s large-scale asset purchase programs (known quantitative easing or QE) on the financial markets. To wit:
“Throughout the last couple of years we have been updating a version of the chart below which overlays each of the FOMC’s asset purchase plans on the chart of the S&P 500. As one can clearly see in the chart and the table below, periods where the Fed was buying bonds have seen stocks rally, whereas periods where the Fed was not actively purchasing bonds saw two of the largest pullbacks for the S&P 500 during this bull market.”
This is something that I discussed previously. The chart below shows the historical correlation between increases in the Fed’s balance sheet and the S&P 500. I have also projected the theoretical conclusion of the Fed’s program by assuming a continued reduction in purchases of $10 billion at each of the future FOMC meetings.
If the current pace of reductions continues it is reasonable to assume that the Fed will terminate the current QE program by the October meeting. If we assume the current correlation remains intact, it projects an advance of the S&P 500 to roughly 2000 by the end of the year. This would imply an 8% advance for the market for the entirety of 2014.
Such an advance would correspond with an economy that is modestly expanding at a time where the Federal Reserve has begun tightening monetary policy. (Yes, Virginia, “tapering” is “tightening.)  David Rosenberg charted this in his note yesterday (via PragCap):
