» Benchmarks for the S&P Blog for Trading Success: Ray Barros

BarroMetrics Views: Benchmarks for the S&P

Today I want to look at possible tools that will provide a timely warning that my scenario - we are seeing a rhyming of the 1966 to 1982 pattern - is wrong.

From an Austrian economics viewpoint, the increase in the money supply without a commensurate increase in productivity will lead to inflation. The US has definitely done that, especially in post sub-prime. But why then no sign of inflation?

For some answers, let’s turn to two charts. Figure 1 is the St Louis Fed Reserve FRED Graph. It shows that bank reserves at the St Louis Fed Reserve were at an all-time high up to Feb 2010. Since then, the reserves have been slowly declining. Figure 2 is a Survey of the Senior Lending Officers. The higher the number above 0, the less banks are willing to lend. From Feb onwards, banks had ceased to tighten lending standards. This does not mean that they had started to ease lending restrictions just that the banks had ceased tightening. We need to see the data well below ‘0′ to say that lending restrictions had eased.

Once ‘quantitative easing’ hits Main Street what can we expect?

Interestingly enough China provides a test-tube illustration. When the sub-prime crisis hit, China embarked on a program of quant easing comparable to that of the US. But unlike the US, the Chinese Govt can tell banks to lend. So rather than the funds becoming stuck at a Fed Reserve, the money was lent out in record time. As a result, inflation in China started being of a concern to the authorities in August 2009.

When market players got wind that the Chinese Government may take steps to curb inflation….well, look at Figure 3, that tells its own story. It provides even more info when compared to the S&P. The Shanghai Index looks set to test the March lows.

So what does this mean for the S&P?

I’d watch Fred Graph carefully.
I’d also review the Survey of the Senior Lending Officers as well as the Survey that measures Bank Reporting for Commercial and Investment Loans. The former discloses the banks’ willingness to lend; the latter shows the demand for loans.

If a drop in reserves is accompanied by a rise in demand, this will mean that inflation is due to rise. The FED will then be facing the same problem that China faced: do we raise rates? At some point the answer will be ‘yes’ unless the FED wants to be faced with run-away-inflation.

For traders, the drop in reserves etc, will signal the possibility of a test of the 2009 lows. ideally these sell warnings will come after the S&P has moved to the Primary Target Zone mentioned yesterday above 1552 but below 1454. That would nicely fit my scenario we are rhyming with the 1966 to 1982 pattern.