Stock Market Correlation – The price / yield correlation between debt and equities has strong foundational roots that tie into an investor’s decision making process relative to investment selection. A Bank of America Merrill Lynch research piece from Hans Mikkelsen talks about breaking this correlation. The meaningful question might be: With a potential rate hike coming, can the correlation between QE withdrawal (interest rate hikes) and the stock market (negative price appreciation) be altered?

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Stock Market Correlation – Fade the ECB tapering talk, central bankers are not going to raise rates

Fade the ECB tapering headlines, BAML’s Mikkelsen advises. He doesn’t explicitly connect dots, but in the back part of the sentence he uses the word “dependence.” In part, breaking the stock market and relative interest rate concern correlation is about breaking the notion that a tiny rate hike is going to have significant negative impact on the real economy.

The ECB has injected a needle in deep – historic negative rates, a violation of text book economics and, for now, proof that “magic people” can “do anything.” Others say QE madness is like a time bomb, with Fed Chair Janet Yellen in the middle of the most delicate surgery of her life. Still others, perhaps more level headed, say the economy is doing fine. This has been eight prosperous years and it will continue to do fine so long as investors are not scared. As proof, if interest rates were to rise without markets really knowing — a topic that has been discussed in the past — this proves the theory that raising interest rates has more psychological rather than material impact.

Mikkelsen, of course, did not use those words. He didn’t exactly explain why to “fade” ECB tapering in this report. It might be because he didn’t think central bankers will have the gumption to revert back to free markets with normalized interest rates, but that would be speculation. Speaking clearly on the issue is typically taboo.

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Stock Market Correlation – Stocks to decline into year end as fiscal stimulus considered

What Mikkelsen does next is perhaps the hot global topic: the fiscal end of government exerting its influence in the economy. Typically monetary and fiscal policy work in harmony. Recently, however, the fiscal side has been content to let central bankers carry the economic water.

This concept of fiscal stimulus getting involved has a global bent, as previously reported in ValueWalk.

At first the talk of the markets centered on Japan. They were tinkering with the notion that the central bank monetary side actually become involved in financing fiscal stimulus, typically involving government spending and debt. The concept was derisively termed “helicopter money,” as a central bank loading up its balance sheet to benefit a nation’s infrastructure was deemed wrought with political concerns, among other issues. Those same concerns did not extend to buying government and corporate bonds as well as stocks.

Japan and helicopter money was a concept that seemed to fade in the distance since its brief July outburst. Now, however, Mikkelsen has his eyes on the center of a Brexit shot heard round the world. He notes that, in part, “concerns about (Bank of England) QE dependence on government support” is one of several factors that could “send interest rates higher,” as much as 13 basis points on the US Ten Year Treasury Note.

If the US is taking the lead at withdrawing QE dependence, it is the Bank of England that were concerns are being raised. But unfortunately the concerns are likely to materialize in stock prices. Citing an August 15 BAML equity report, Mikkelsen is looking for the worst. This “new norm” has the stock market to declining before year end.

In this environment Janet Yellen and her quantitative team at the New York Federal Reserve have several tools to combat a declining stock market. Watching this battle might require popcorn.