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Sunday, 16 September 2012
SPX Correlation with QE1, QE2, OT and QE3
The Law of Diminishing Marginal Returns at Work
The following shows the SPX correlation with QE1, QE2, OT and lets us have a rough guide of how QE3 would be like.
In Economics Theory, there is always the Law of Diminishing Marginal Returns (LDMR). When the maximum marginal returns has reached, the returns start to get less and can potentially turn into negative returns with each increment of a specific X.
The SPX is currently behaving with all the characteristics of the LDMR.
When too much money floods the market, it is initially good, as it can depress the interest rates and stimulate production. Incomes increase while inflation levels are subdued in a recessionary economic environment; however, the effect becomes less and less with each flooding operation (Q.E) as can be seen from the SPX chart (Cost of Production C.O.P eating up growth); flooding operation will reach a point where negative returns set in, which in this case, the now over-excessive liquidity-stimulated inflation (on oil, raw materials for production, necessities) will maliciously eat into growth, corrode GDP, evaporate employment, and spark another depressing vicious cycle even though interest rate can still theoretically remain low. The negatives will flex over the positives which is the point LDMR sets in.
Before the QE3 was implemented, the media and majority of funds worldside had already anticipated it. Likely, QE3 has been absorbed by the market in the several weeks leading to the QE3 announcement, and the market may need to start pricing in the negative returns now. This will go with market selling/distributions as oil spikes up and while majority of market herd (retailers/small fishes/investors/everyone with experience in QE1 and QE2 expecting market to continue to rally) are buying into it. Classical conditioning at work is often what kills majority of market participants because they are already brained-washed based on the previous two or three histories they had.
The relatively good or steady performance in financial markets should, at best, tide until the US presidential election. At worst, selling may start before one even anticipates it. During this time to presidential election, it is highly likely that Big Hands and Insiders are engaging in distributions and secret sellings/off-loadings to majority of market participants/investors, who are still classical conditioned based on their experiences with QE1 and QE2. They may find that their experience with QE3 or QEx differs from what they would expect as market likes to do the opposite.