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Fed Balance Sheet Update

(February 4, 2011)

Note: I will be in Sedona, Arizona this weekend enjoying the scenery and the hiking trails.  I will thus be penning a slightly abbreviated commentary this weekend.  I apologize for any inconvenience and I wish all our subscribers a happy Chinese New Year of the Rabbit!

Dear Subscribers and Readers,

I apologize for the delay in our mid-week commentary (we were waiting for the latest Federal Reserve data).  I want to start with a review of the size of the Fed's balance sheet—that is, the amount of securities held (which include Treasuries, agency debt, and agency MBS) on the Fed's balance sheet.  From late June to mid-November last year, the size of the Fed's balance sheet (per the amount of securities outstanding) has remained steady in the $2.04 to $2.07 trillion range.  Since the implementation of the Fed's “QE2” easing policy in mid-November, securities outstanding on the Fed's balance sheet has rocketed higher by nearly $200 billion as of February 3, 2011—a record high.  As shown on the following charts, the Fed had been purchasing more Treasuries as the agency debt and agency MBS on its balance sheet matured over the last six months:

Since mid-November, the Fed has purchased a net $15 billion of securities on a weekly basis.  While the amount of agency securities (which includes debt + MBS) outstanding has declined by over $90 billion, this has been more than offset by the $285 billion in Treasuries purchases over the same period.  More important, the size of the Fed's balance sheet has rocketed higher by nearly $200 billion in the last 2 ½ months—to a whopping $2.24 trillion.  Moreover, with the U.S. economic recovery having taken hold and with U.S. leading economic indicators still strong, I believe the Federal Reserve should start thinking about ending its “QE2” policy.  It is ironic that just over 6 months ago, the Fed prematurely ended its easing policy—and yet they now “have the foot on the gas pedal” despite an economic recovery taking hold.  Moreover, with oil futures now at over $100 a barrel, and with global food prices making record highs, the Fed should be mindful of inflation and end its QE2 policy over the next couple of months.

In the meantime, the majority of our technical indicators have continued to deteriorate.  For example, the NYSE CSO McClellan Summation Index (as shown below, courtesy of, peaked in mid-November and has consistently made lower highs:

More ominously, the NYSE CSO McClellan Summation made a slightly lower peak in early January, and has declined significantly despite an ongoing rise in the stock market!  This (among other technical indicators) is a flagrant non-confirmation and suggests that overall breadth has been weakening substantially. This also confirms the weakening of our liquidity indicators—as well as the technical deterioration of Lowry's proprietary buying power/selling pressure indicators.  We will remain completely neutral in our DJIA Timing System as we believe a 5% to 10% correction in U.S. stock prices is imminent.

Signing off,

Henry To, CFA, CAIA

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