Sunday, September 27, 2015

Relationship between Fed balance sheet and the S&P 500 index

The intervention of the US Federal Reserve Banks has been useful to get the US out of the recession. There has been a huge excess of liquidity poured in the financial market. You can read the details of the “QE” and “LSAP” efforts from the Fed here: https://www.stlouisfed.org/publications/regional-economist/january-2014/the-rise-and-eventual-fall-in-the-feds-balance-sheet

Whether intentional or not, there is now a tight correlation between the S&P index (i.e. the market) and the Federal Reserve Banks.




As the recent correction suggests, the financial markets are very dependent upon the flows of liquidity from the Fed.

What does this mean for investors?

The direction of the market in the short term is difficult to predict. I expect a lot of volatility. One of my colleagues significantly reduced his exposures to stocks recently due to this. Such moves are drastic, but understandable for investors looking for capital growth.

For Dividend Growth Investors, the focus is on the long term dividend growth and income. From that perspective, any short term dips are just opportunities to buy companies at better yields. The key assumptions are that the underlying business continue to grow their earnings and dividends and of course, continue to stay in business.

I don’t think the fall in the balance sheets of the Feds will significantly affect the balance sheets of good quality companies.

When I started DGI last year, I could only buy a few select companies. With the recent downturn, my buying choices are expanded. For example, ADM and ABT are companies that moved from my watchlist to buylist. Just a few months ago, their yields were in the low end of my yield thresholds. Moreover, the yields of some companies - e.g. KMB, UL etc. are very attractive trading at fair value or better.

For me, it is a good time to rebalance my portfolio by adding to my holdings which are under represented. Also, it is also a good time to add new companies in my weaker sectors.

D4s

Long KMB, UL

2 comments:

  1. Definitely some interesting times ahead, as you said we just have to look for opportunities on quality companies with strong balance sheets and not buy anything we won't be happy to hold and collect dividends on should the share price turn on us quickly.

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    Replies
    1. Dividend Chimp,
      Yes - buy quality and hold for the income. Time will smooth things out.
      D4s

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