Thursday, 29 November 2012

Is the U.S. Private Sector Financial Surplus signalling future Upward Movements of the S&P 500?

The U.S. private sector financial surplus (PSFS), the difference between Gross Private Saving and Gross Private Domestic Investment, shrunk to USD 772 billion as of Q3 2012 according to numbers released today. The surplus was the lowest since the onset of the financial crisis since Q3 2008, but remains high in a historical perspective.

The surplus also remains high in relative terms, presented here as a ratio to Gross Private Saving (let's call it the "PSFS ratio"). The current ratio is 27.1% while the average since 1973 is 6.8%. The ratio peaked at 43.0% in Q2 2009.

But here is an interesting observation: since 1997 there has been a relatively strong negative correlation between movements in the S&P 500 and movements in the PSFS ratio. More specifically, reductions in the ratio have tended to be accompanied by the S&P 500 index moving up and increases in the ratio have often been accompanied by the S&P 500 index falling. This is depicted in the chart below, where the PSFS ratio has been inverted (to depict the co-movements).

As the PSFS ratio remains high in a historical perspective, there is a reasonable possibility it could fall further, hence possibly fuelling further upward movements of the S&P 500. But even if the ratio were to fall further, the S&P 500 is by no means cheap these days which could hinder any further upward movements.

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