There is a clear relationship between the rise in the S&P 500 Index from its March 2009 low and the Federal Reserve’s purchase of US government debt instruments, which it calls “quantitative easing” (QE). Another term for it is money ‘printing’. The Fed is simply turning US government debt into more dollar currency, which of course debases the dollar. It also explains the correlation in the above chart.

Note how the S&P Index started climbing with the commencement of QE. The S&P dropped early this year when the Fed announced QE would end. Interestingly, the stock market soon rallied thereafter, probably because few believed that the Fed would really take away the ‘punchbowl’. But it did, and the S&P has been in a downtrend ever since.

When more dollars are being created than demanded by economic activity, this surfeit of dollars must go somewhere. This observation is particularly true when real (i.e., inflation-adjusted) interest rates are so low that bank deposits become unattractive, as is presently the case. The above chart illustrates that one of the places where these newly created dollars ended up was the stock market.

Now that the Fed has stopped printing, the S&P 500 Index not only stopped rising, but began falling to reflect the true state of underlying economic conditions. Consequently, I expect that there will be new calls in Congress for another stimulus package, but more immediately, it seems likely that the Federal Reserve will recommence its purchases of US government paper. Quantitative easing, I expect, is about to get a second chance at reviving the moribund US economy.