Without Ben, the S&P 500 would be at 1000 via Paul Jackson of SocGen

Just as Mr Chips finally had to say goodbye to his wards, Ben Bernanke is now bidding farewell to the bubbles he has created (let’s hope he does it with more grace than his predecessor).  Equities expressed the greatest sigh of relief that tapering had at last started (and that rates will stay lower for longer), with an immediate jump in the S&P 500 (.INX) and continued gains throughout the session (futures have stabilized overnight).  I have always argued that equities would eventually continue higher, putting more emphasis on the improving economy than rising bond yields.  I also felt that QE had not really impacted equities that much (valuations are hardly in bubble terrain). 

S&P-500

 

However, the second chart gives pause for thought (if you believe there is a link between QE and equities).  First, if QE had never happened and the Fed’s balance sheet had continued on the pre-QE trend, it would support an S&P 500 index of 1000 (assuming the world had not fallen into depression).  This would give a Shiller PE of around 14, close to the 15 that most of us consider normal.  Second, tapering implies the Fed’s balance sheet will grow less rapidly, so upside support for equities will diminish (2014 will not be as good as 2013 – SG’s end-2014 target is 1950).  Third, as the Fed eventually allows its bond holdings to run-off, the balance sheet will shrink back towards the pre-crisis trend (by around 2022 according to Aneta Markowska – see link).   By then, the balance sheet will be about half of what it is today and the S&P 500 should be around 1400 if we make a literal interpretation of the chart.  Thanks Ben.

   S&P 500