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US stocks: near-term correction?

Posted on Monday, December 6, 2010 at 01:03PM by Registered CommenterSimon Ward | CommentsPost a Comment

The Federal Reserve's QE2 securities purchases have started to lift the US monetary base (i.e. currency in circulation plus bank reserves) but it remains 8% below its February 2010 peak.

US stocks broadly tracked the monetary base between QE1 in late 2008 and this summer but broke to the upside when the Fed signalled QE2 – see first chart. They may need to tread water or correct over the next couple of months, although the base should eventually rise well beyond the level currently implied by the market if the Fed fulfills its intention of buying $600 billion by mid 2011 and fails to sterilise the impact on reserves (i.e. to about $2.5 trillion versus the current $1.98 trillion).

A comparison of the recent recovery in US stocks with an average of performance after six prior big bear markets, discussed in several previous posts, also suggests near-term consolidation – second chart. The market is exactly in line with the "six-bear average", which meanders around the current level before another advance next spring.

US stocks traded above the six-bear average during the first year of the rally from March 2009 but have been mostly in line or below since G7 real narrow money growth fell beneath industrial output expansion in early 2010. As previously discussed, however, a positive "liquidity cross-over" could occur in early 2011. (Caveat: the range spanned by the historical recoveries widens as the distance from the 2009 low extends, suggesting that the average will become less useful for "anchoring" a forecast.)

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