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Sunday, September 26, 2010

Is the Fed Priming the Stock Market?

With billions of dollars leaving the stock market and fleeing toward the bond market every week, I have been trying to find out where the growth in the Dow has been coming from.  Seems to me if you have billions leaving the market, the stock market would not be rising (not that I want it to fall, but for me to invest in a rally, I need to know where the money is coming from to assess if it is real or fake rally).
I became really interested in located the source of the money, as the stock market has had a tremendous run up since Mar09.  Then I heard of this thing called POMO (Permanent Open Market Operations) which is performed by the FRBNY (Federal Reserve Bank of NY).  POMO is the purchase or sale of Treasury Securities on an outright basis adds or drains reserves available in the banking system, the same banking system that can also be an investment house as well (like BOA, CITI, Goldman Sachs and etc). The funds actually went to the primary dealers who are the same as in the list above.

Now remember, when the government needs money, the Fed creates money out of thin air, which is given to the big Fed banks, these banks then use that money (really it is like they print it, just with permission) to purchase Treasuries (which they draw interest on).  In POMO, the Fed uses his balance sheet to purchase these Treasuries from the banks (in exchange for cash) for them to use for investments or whatever (loans really aren't bringing in the money these days, so stock investments bring a greater return and Oh by the way it pumps up the market.  Here is a drawing I am borrowing from Chris Martenson of with the year 2009 history of POMO and the DOW.
I noticed that this correlation was missing 2010 data, which has seen some turbulent times so I decided I would track it going forward.  We all know that since May10 the market has been going lower into Aug10, then Sep 1st we miraculously came back (same time big investment house managers come back from their summer vacations).  At first I thought that maybe this was the big money getting back in, but the big money uses investors money to do so (mutual funds, see the money flows chart above).   With so many withdrawing from the stock market and draining their 401k's to live on, I figured maybe POMO was a factor.

Apr10 the Dow clawed back to the 11,205 level, but then started to fall.  In July/Aug10 the main media started getting on-board with the idea of a double dip recession and August began to be an ugly month with chances of a double dip mounting(all economic indicators looked bad).

August 17 2010 was the first day of this year that the Fed started purchasing treasuries again since Sep09.  As you can see there are some POMO days at the end of the month of Aug10, but the money managers weren't back until September (but it did provide cash to the managers for their return).  As fate would have it, Sep 1st 2010 was when the run up in the Dow really took off, before that it was moving in a channel and in a downward direction.   A total of $33.702 Billion was pumped into the markets from POMO purchases from 8/17/2010 till 9/24/2010.  According to the fund flows since (approximately) the same time frame we have had $17.854 Billion come out of the stock market by investors.

Also of note, after the Fed stared purchasing securities, the main media started hyping the economic indicators (more of an observation from my standpoint) as being excellent news (even though when you peeled back the numbers they were actually bad).  The only economic number that I can see that has been positive lately was the Core Durable Goods number (which takes out transportation), the Non-Core Durable Goods number was actually bad.  

ZeroHedge had said that the primary dealers have been purchasing shares of AMZN and AAPL after POMO actions.  By the way, AMZN trades at an PE of 66.55 and AAPL trades at a PE of 22.  Of note there are 1284 stocks that trade in a PE range from 20 to 100 and 149 stocks that trade at a PE ratio between 100 and 2000 currently (and they say the market isn't overvalued). 

Judging by the run up in September 2010, it does have strong correlation.  In a related story, Saturday Sep 25th 2010, ZeroHedge published an Overview of the Feds interventions, which can be viewed here.

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