The following is the S&P 500 chart in 2011.
*Read the entire history of the U.S. stock market here.
The S&P 500 had been going up pretty much nonstop since November 3 2010 when the Federal Reserve announced QE2 (QE2 was scheduled to end in late June 2011). The following chart from CalculatedRisk shows just how crucial quantitative has been to the 2009-present bull market in U.S. equities.
Q4 2010 (January 2011) earnings season was mixed. Tech companies released good earnings reports while a few banks released bad reports due to new Obama financial regulation costs.
There was a small 7% correction from late-February to mid-March 2011. Our quantitative model predicted this small correction (we knew that it would be a small correction and not a big correction).
From the news perspective, this small correction coincided (but was not caused by) the Libya revolution. Prior to the Libya revolution, none of the Middle East revolutions (Arab Spring, Egypt) had impacted an oil rich country. Throughout this small correction, the S&P fell whenever oil spiked due to news from Libya (strong inverse correlation). Some investors were afraid that the Libya revolution would adversely affect the oil supply. In addition, worries that the Libya revolution would spread to other Middle East nations kept oil prices elevated for an extended period of time.
But at the bottom of this small correction, the S&P broke its correlation with oil. The S&P started goin up even though crude prices kept on going up.
Our quantitative model also predicted the entire May – September 2011 big correction. We knew that it would be a big correction and not a small one.
May 9, 2011: Standard and Poors (ratings agency) downgraded Greece’s bonds again. This news was not surprising because there were any rumors before May 9 that Standard and Poors would downgrade Greec’s debt. But since the U.S. stock market always waits until the last minute before it sells off, investors only started to worry that Greece would contaminate the other PIGS after May 9 when the downgrade occurred. From May – July 2011 the financial media focused on whether or not Greece would get a bailout from the Eurozone.
Another really interesting point is that in early May 2011, commodity prices (oil, gold, silver) were moving in tandem with the S&P 500. Historically, S&P moves in tandem with commodities when commodities crash from the top of their bull markets. For example, the S&P fell from February – March 1980, coinciding with gold/silver’s crash in March 1980.
The only times this correlation failed were in February 1974 and March 2008. However, keep in mind that these were not silver’s true bull market tops. Silver’s bull market in the 1970s topped in March 1980, and silver’s bull market in the 2000’s topped in May 2011.
May 16, 2011: The U.S. hit its federal debt ceiling. The Congressional fight over whether to raise the debt ceiling begins (Democrats and Obama want an immediate raise of the ceiling, Republicans oppose).
By May 2011, everyone knew that QE2 was scheduled to end in late-June. So a lot of investors didn’t want to buy stocks.
May 20, 2011: Fitch (ratings agency) cut its rating for Greece’s bonds. Standard and Poors cut its outlook on Italy from “stable” to “negative”.
In addition, U.S. economic data had started to deteriorate by May 2011.
In essence, the May-August 2011 correction had 3 negative fundamental factors: U.S. macro economic deterioration, Europe worries (sovereign debt), and QE2 was set to expire. The debt ceiling fight was not a negative factor. Everyone knew that the debt ceiling fight wasn’t real. The S&P 500 often goes up during government shutdowns, because everyone knows that a government shutdown is just for show! A government shutdown is not a real concern.
June 13, 2011: Standard and Poors downgraded Greece’s debt again.
July 12, 2011: Moody’s (ratings agency) cut Ireland’s debt rating.
July 13, 2011: Fitch downgraded Greece’s debt again.
The S&P usually goes up during earnings season. However, even the second-half-of-July 2011 earnings season could not prevent the S&P from falling: it could only prevent the S&P from crashing. The instant Q2 2011 earnings season was over, the S&P started to crash.
Towards the end of July, Greece’s problems were mostly resolved because Europe agreed to a bailout package. Thus, Greece was no longer a concern to the financial markets. However, U.S. economic data was still deteriorating in July 2011.
During the last week of July, the S&P went down on debt ceiling fears. But Congress made a deal on July 31 regarding the debt ceiling. Nevertheless, the S&P still crashed during the first week of August.
August 8, 2011: Standard and Poors downgraded U.S. debt. This added fuel to the fire, so the S&P crashed (again).
Throughout the August 2011 bottom, many investors and banks were predicting that the U.S. would enter into a recession. Even Warren Buffett went on CNBC to state that the U.S. economy had noticeably slowed down.
September 21, 2011: the Federal Reserve announced Operation Twist , which would convert $400 billion of the Fed’s near term Treasury notes to long term Treasury notes. This form of QE would essentially depress long term rates. The markets didn’t care, and sold off for another 1.5 weeks before ending the May-September 2011 big correction.
October 12, 2011: the Fed’s minutes show that the Fed is considering a new round of QE (QE3) in the future if Operation Twist doesn’t work.
Oct 27 2011: the EU agreed to expand its bailout fund (in case other PIGS need it), putting an end to the Euro fears. Oct 27 is the top before the S&P’s November 2011 61.8% retracement.
November 1, 2011: Greece announced that it would hold a referendum on whether or not to accept the EU’s bailout package. Beggars can’t be choosers, but apparently Greece didn’t understand this point. Greece very quickly voted to accept the bailout.
Throughout November 2011, there were a bunch of other meaningless fears about Europe’s problems. Some investors feared that Italy would need a bailout too. Others feared that Europe’s problems would be contagious and affect U.S. banks. These were all just bullshit excuses and noises.
The good news is that by November 2011, U.S. economic data had clearly improved.