RJH writes...another graph to complement yesterday's conclusion

Two years hence, give or take, often has been the answer.

(Click for larger image) Exhibit 1:YoY% change in liquidity & SPX500 (RH scale), 1975-2006 (NB Crises and equity corrections are lined up with the liquidity oscillator

On the face of it, the immediate outlook is poor for the S&P500. But offsetting data, as in this graph, is not science. Depending on which period the best fit is sought for, offsets may range between 18 and 36 months. And, if one believes the Big One has already begun, equities are currently anticipating the impact of evaporating liquidity.

Previous declines in the rate of liquidity expansion – or even when it has contracted – have not automatically led to year over year declines in equity returns, or negative returns. The bottom line is that the two data sets are correlated by about 35%.

In the context of US economic imbalances, what would seem to matter now is reducing equity risk until it is clear how orderly the unwinding is turning out.

Sources: Federal Reserve Archival System (FRASER); Federal Reserve Economic Data (FRED);and Yahoo Finance

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