Fed vs S&P
Source: Doubleline, ZeroHedge


The chart above has been making the rounds ever since Jeff Gundlach showed it in his most recent quarterly update.

Call it a Rorschach test: It can be used to demonstrate pretty much whatever the author desires. I most commonly see it as “proof” that, but for the Fed’s QE program, this market would be flat or much worse. At the risk of creating a straw man, I find that a gross oversimplification, and one I would like to spill a few words discussing.

Let’s agree to a few simple factors surrounding the Fed’s market intervention: First, on the economy, there can be little doubt that the combination of Bond Buying (QE) and Zero Interest Rate Policy (ZIRP) is having a major impact on anything credit driven. Homes and Autos especially have seen higher volumes (Cars) and higher prices (Houses) than they would otherwise. This is a non-minor factor to both GDP and Job creation.

Next, there is a Fed component to positive earnings. The low cost of credit is not only encouraging consumers, it makes corporate financing much cheaper. Cheaper borrowing = lower costs. Hence, the Fed is contributing to record corporate profitability.

But as is stated so unequivocally in the chart title above, lots of folks seem to think QE is the prime, if not the only driver of equity markets. Here is where I depart company from many people who believe the Fed is the sole driver of markets. First is the standard single variable error we have lamented over the years. Next is the tendency to ignore the oscillating, reflexive nature of markets. Just as every sell off eventually becomes oversold, each rally eventually becomes overbought. George Soros made the case that there is a circular relationship between present market action and subsequent market reaction. A “bidirectional reflexive relationship” is how some have described this. Put more simply, it is inevitable that pullbacks occur after rallies. THAT IS HOW MARKETS PROGRESS.

Ignoring this to prove the impact of the Fed on markets is an admission of trading and market ignorance.

There is no doubt that the Fed is a large factor in our economy; the impact on both bond yields and risk assets is very significant. But to claim that markets are purely Fed driven is to misunderstand the basics of how equities function.

Please stop over-simplifying this . . .




Single vs. Multiple Variable Analysis in Market Forecasts (May 4th, 2005)

Markets Are Rorschach Inkbot Tests (March 2nd, 2009)

Category: Federal Reserve, Investing, Technical Analysis

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

20 Responses to “Revisiting Reflexivity: Contextualizing Cause & Effect”

  1. rd says:

    I think the big story is how LITTLE the Fed is able to impact things.

    We have unprecedented ZIRP and QE and yet have a pretty anemic job recovery and nothing stellar for corporate earnings. To a certain extent the Fed has been pushing on a rope. normally, they should have been able to accomplish our economic metrics and still have, say, a 3% or so Fed Funds rate without entering into the long Treasury market in a big way.

    After several years of low rates like that, people would normally already be nattering about over-heated sectors of the economy and when will the Fed start to take action to slow things down – now we have a Fed announcing that these policies will likely be in place for 2 more years and people are wondering if there is more they can do to jolt the economy.

    It appears that there was some fundamental shift in the 1980s where jobs recoveries became more and more anemic over time and median income began to stagnate. This decade appears to have brought this to a crescendo level. It is going to be interesting to see what structural change is going to have to occur to reverse that 3 decade trend.

    • MarkKlose says:

      The Fed is not operating in a monetary policy vacuum; working against QE have been state & local austerity from the start, then Federal austerity starting in 2011 plus an engineered triple dip in the EU & UK. Those are a lot of headwinds.

  2. MarkKlose says:

    While it is certainly true that low rates can contribute to corporate profitability, due to slack demand in many industries we’ve seen significant corporate deleveraging over the last few years with massive cash building on corporate balance sheets. That cash is earning little and is a drag on ROE. The most recent Fed Senior Loan Officer Survey reports that demand for C&I loans is just now starting to pick up and that while underwriting is still tight, it is easing modestly. This said, there are several industries that have clearly benefited and many have boosted eps with low-cost financing of buybacks.

  3. [...] Revisiting reflexivity: contextualizing cause and effect (TBP) [...]

  4. hack says:

    The single largest impact ZIRP has on any asset price (including stocks) is its role on the discounting of future cashflows. That is the Fed’s whole/main point, isn’t it? Inflate/maintain residential/commercial real estate prices so banks have time to heal their balance sheets.

    Lowering the discount rate through ZIRP cannot be directed only to real estate, therefore any and all assets benefit. One cannot expect ZIRP to only affect one component of the capital stack. If ZIRP inflates bond prices, then it will inflate equity prices (i.e. you will not have lower expected returns on corporate bonds & junk bonds and at the same time not expect future returns on stocks to not also be lowered).

    No one knows the precise impact of ZIRP on stock prices but it is large and it has definitely lowered expected returns through increasing price – just as it has for bond, buildings, houses, etc.

  5. Ingolf Eide says:


    On “reflexivity” though, didn’t Soros coin the term to describe instances of a positive feedback loop between a market and its underlying reality?

  6. Dan EE says:

    Really interesting post and great blog. I’m new to investing but this – the analytical method – chimes with a lot of the political economy I have read. Barry – you mention “bidirectional reflexive relationship”. Where can I find out more about this approach to markets?

  7. b_thunder says:

    Forget for a second about the message. What about the messenger? It seems to me that Jeff Gundlach’s recent market and individual stock “calls” proved to be correct. He’s not a “broken clock” type predictor. His fund’s performance over the years speaks for itself.

    Bernanke openly admits that Fed’s policies are aimed at promoting the “wealth effect” which they hope will help create more jobs (and to which i say: trickle me down once – shame on you, trickle me down twice…you know the rest.) Gundlach’s chart is basically an admission of how much Bernanke is succeeding in his “wealth effect” drive.

    But I’m afraid that we won’t know who is right and what the long term effects the QE will have until this economic cycle plays itself out, whether in the context of 2000-20XX bear market with several bull market rallies, or as a new 2009-20XX bull market after it ends with a bear phase as every previous bull market. Unless of course you believe that Bernanke’s Fed will be able to accomplish the Soviet-style central planners’ wet dream and permanently abolish the bull/bear, greed/fear, expansion/contraction business cycle!

    • I find Gundlach’s presentations to be thought provoking and well considered (‘though he was 300 points early on Apple). And while it is his chart, it appears others have run off with it to illogical extremes.

      • quadrillion.me says:

        By others, you mean ZeroHedge?, the porn site for doomer-preppers?

        Tyler Durden serves a market niche of converting everything to doom porn and selling it to the target audience, who revel in the form of unprecedented circle jerk of schadenfreude that I haven’t seen in any other community.

        Unfortunately, there are many who think that Zerohedge is a financial analysis site.

      • b_thunder says:

        Perhaps in this case he’s also a few hundred S&P points too early? Early or not, if I had to bet, I’d never bet against him.
        I think here he lays down his view of the Big Picture, i.e. what’s likely to happens when the cycle (music) ends.
        On the other hand I perfectly understand that those who manage other people’s money cannot afford to miss out on the “generational” rally in equities.

  8. jacobh says:

    The recent run-up in Europe (mainly the German Dax; 10%!) since the bad figures 2 weeks ago has nothing to do with the expectation (and fulfilling) of a rate cut by the ECB?
    The economic situation in Europe is completely detached from the main stock indices. The crisis is now even hitting the Netherlands.
    Throwing liquidity at the market must be the main driver here, as the positive news coming out recently were the (previously downgraded) NFP.

  9. Moss says:

    I believe it is all a bit premature since no one knows what will happen when and if the Fed either stops with new flow and or begins to sell. When I look at Japan and the massive front running that has occurred one must wonder how reflexive the correction will be.

    • Angryman1 says:

      the problem is, the FED isn’t putting much new flows out there. Most of it looks like typical recovery as the financial crisis moves further away.

      If the FED “stops”, I don’t see much happening. If the FED sells, I don’t see much happening. You overblow the FED and what it really can do.

  10. phillips49 says:

    Intellectual pushups! No argument with the concept of reflexivity. But neither can I discount the chart just because it is a single variable chart subject to single variable error. The repeatable market pattern that reflects the cumulative sentiment covering many variables is unmistakable during and absent the Bernanke put. No one knows of course where we would be absent stimulus, but I rather suspect we would still be in bunkers hording gold and USTs waiting for an all clear from a deflationary spiral and the “Market” would have responded accordingly.

  11. [...] goes this one is a pretty big, existential one that should be addressed. Barry Ritholtz at the Big Picture talks about the Fed’s effect on the markets in a post [...]

  12. Monty Capuletti says:

    It seems pretty clear to me, that chart excluded. Remember your 9th grade calculus- K I S S (Keep It Simple Stupid) and try to imagine that you were the one forecaster who was actually able to forecast S&P (not individual co’s) Earnings accurately 1 year in advance, every year. You were so good, you could nail the S&P # to the dollar, or even to the decimal point, and actually determine what real S&P profit growth was every year. Then, assume you added an Index price forecast based on what you deemed the right multiple- likely lower when you saw lower growth, higher when you showed higher growth…GUESS WHAT?? YOU WOULD BE MAJESTICALLY WRONG, probably EVERY YEAR!!!!

    WHY?- What (I’ll guess) 99.9% of investors miss is that in the last 65 years, S&P Earnings Growth has NEARLY ZERO correlation to S&P Price performance, outside of 2008- GFC shook things up when credit stopped-Lehman.

    Some of the best eps growth years showed some of the worst returns, and some of worst earnings growth years showed some of best returns! Why is that? What’s the point? Read your Marty Zweig (and even your Buffett here- http://money.cnn.com/magazines/fortune/fortune_archive/1999/11/22/269071/)
    and remember that interest rates (ie- monetary policy) and market expectations surrounding them rules EVERYTHING..All else is noise..

  13. [...] Revisiting Reflexivity: Contextualizing Cause & Effect at The Big Picture Since the first round of QE, many investors have scrutinized and analyzed how exactly the Fed’s massive stimulus measures have been affecting the markets. In this insightful piece, Barry Ritholtz takes a closer look at this subject, highlighting the market reactions to the FOMC actions. [...]

  14. [...] Revisiting reflexivity: Contextualizing QE vs SPX, cause & effect | The Big Picture Too many people attribute the entire SPX recovery since March 2009 to the Fed’s QE. (Annotated chart: SPX during QE1/QE2/OT/QE3/QE4) Barry notes the folly of single variable analysis, and reminds us of the bidirectional reflexive relationship (i.e. markets progress in a circular cycle between overbought & oversold). [...]