This chart makes a compelling case for the bears that stocks and bonds are likely going to keep falling as they’ve mostly done this year.

But all hope is not lost as Ed Yardeni of Yardeni Research points out in this brief commentary accompanied by that dreaded chart and another one that offers a ray of light for the bulls.


by Ed Yardeni, Yardeni Research

We’ve saved the worst for last.

It’s probably the most oft-shown and most compelling chart included in the PowerPoint presentations of the bears to make their case.

It shows the S&P 500 stock price index versus the Fed’s holdings of US Treasuries, agency debt, and mortgage-backed securities.

Joe and I added a dotted line to track the Fed’s qualitative tightening 2 (QT2), which ramps up in September and will reduce the Fed’s holdings by $95 billion per month, on average.

We certainly agree that all the QE programs that expanded the Fed’s holdings of securities contributed to the bull market from 2009 through 2021.

But they weren’t its only support.

The S&P 500 always rises along with earnings during economic expansions, and the economy was mostly expanding over this period (except for a severe but short-lived recession in early 2020).

The fourth round of qualitative easing (QE) undoubtedly boosted the S&P 500’s valuation multiple.

But the forward price-to-earnings ratio (P/E) has already corrected significantly, falling from 22.5 at the beginning of 2021 to a low of 15.3 on June 16, and back up to 17.5 on Friday.

The question is whether there will be enough other buyers of Treasuries, agencies, and mortgage-backed securities to offset the Fed’s QT2.

Keep in mind that before QT2’s $95 billion-per-month paring of the Fed’s balance sheet, QE4Ever expanded it by $4.7 trillion from February 2020 through May 2022.

Who might fill the void in the bond markets left by the Fed?

Consider the following:

(1) US Treasury.

The good news is that the federal government’s budget deficit has been shrinking significantly as pandemic-related outlays have decreased while tax revenues have been boosted by inflation.

Over the past 12 months through July, the deficit is down to $1.0 trillion from $2.9 trillion a year ago on the same basis.

(2) Commercial banks.

So far this year, commercial banks have seen their deposits increase by $172 billion through the August 10 week, while their collective loan portfolio has expanded by $786 billion.

They’ve stopped accumulating securities and have sold $84 billion ytd.

(3) Bond funds.

Bond mutual funds and bond ETFs have purchased just $87.4 billion of these securities over the 12 months through June, down from a comparable record high of $1.1 trillion during April 2021.

As it turns out, there was an alternative to stocks, namely bonds, but they incurred huge capital losses over the past 12 months as yields soared.

So it may take some time to bring investors back to the bond market at scale.

(4) Foreign investors.

The most aggressive buyers of bonds in the US capital markets have been foreign investors.

Over the past 12 months through June, they purchased $840.9 billion in the US bond market, led by $618.8 billion in Treasury notes and bonds.


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