Dow Chart Shows How The Fed Manipulates The Market

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(photo: Getty royalty-free images)

As the meme goes, ”Well that escalated quickly.”

On October 15 I wrote that the market should go sideways because the Fed would manage asset prices through QE/Reverse-QE.

My theory goes that the Federal Reserve is using an index moving average to flip between QE and reverse-QE to manage the drawdown of its balance sheet in such a way as to not crash the market.

I picked a 200 day moving average as it’s a market meme too. We all hear pundits talking about breakdown through or up or bouncing off the 200 day moving average, so what better way for the central bank to send a signal that this is where the support lives. Breaking through the 200 day moving average is also a point where crash-inducing panic will start to accelerate, so it would make sense for the Fed to pull its QE lever then.

Of course, it is just a theory.

This is where we were when I wrote about that:

Plotting the past of the DowCredit: ADVFN

This is where we are today:

The Dow movement in the last few daysCredit: ADVFN

As circumstantial evidence I think this chart is evocative.

So where does this put us?

Firstly, as I wrote at the beginning of the year, “something changed” and that a new era was upon us. This era is one where Federal Reserve reverse-QE sets the trend and the trend is sideways. This will go on until the Federal Reserve feels its balance sheet is the right size and no one really knows how low that is.

Here is their chart:

The Federal Reserve chartCredit: FederalReserve.GOV

It is quite a scary chart because for a start, the scale is trillions of dollars. The balance sheet has come down $300 billion so far and if you are super-bearish there is another $3 trillion to go.

That is roughly another three years of reverse-QE and at best sideways range-bound movements.

However, it would seem likely that the new normal for the Fed balance sheet could be higher than the pre-crash $1 trillion, let’s pick $2 trillion, so then we would be in for only two years of sideways trading.

General money supply growth should counteract reverse-QE and ‘strangely enough’ that’s running at $1 trillion a year, the same as reverse-QE liquidity supply shrinkage.

So all should be well… should be.

So what to do?

The simple answer is buy the dips and sell the rallies. This is called swing trading and is great as long as the market swings. The trouble comes when it does not and you get left out of the market on a break out rally or loading up at a false bottom that then collapses. Worst still, if you trade it long and short, then you get hammered at both ends when the swing trend breaks.

Personally I’m fine buying cheap stocks and selling non-cheap stocks over the cycle. With more certainty that the ground isn’t going to open up to swallow me, I just lower my targets and follow the cycle.

The trend will end at some point either because on the down side something awful happens as per 9/11 or on the long side the Fed has got its balance sheet in order and growth then pushes the market up.

But at least the Fed website tells you when the latter is happening, so we should get a good steer on when that is happening.

So with fingers firmly crossed and a constant need for vigilance and the flexibility to adapt to changing theories and circumstances, swing trading is a go.

Clem Chambers is the CEO of  private investors Web site ADVFN.com and author of Be Rich, The Game in Wall Street and Trading Cryptocurrencies: A Beginner’s Guide.

2018-10-17 04:58:00

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