The Money Supply & The Stock Market
Published February 23rd, 2009 in Economy Tags: Barrons, bubbles, deflation, inflation, initial public offering, IPOs, M2, monetary policy, money supply, per capita, Poire, rate of change, real estate, sentiment, tech stocks.On a grand scale, you could argue that the level of the stock market is set by two forces: the supply of ‘paper’, which comes from initial public offerings (IPOs), secondaries and other corporate actions, and on the other side, the demand of stocks which is not only influenced by the sentiment of investors but also by valuation and perhaps most importantly, by the supply of money in the economy.
The amount of money sloshing around the economy matters because eventually it has to find a home. In the past decade we’ve seen it rush into two markets, causing sequential bubbles in tech stocks and real estate.
One way to look at the relationship is to chart the change in change of money supply and see how it corresponds to the market and the economy. The chart below shows 35+ years of monthly data but before you can make sense of it, some explanation is needed:
Data: St. Louis Fed (FRED database)
M2 is a widely used measure of the money supply but since inflationary and deflationary periods can warp it, we look at inflation adjusted M2 (using CPI numbers). This gives us ‘real’ M2 which is more useful to compare across time. But we also have to account for the number of people in the economy because everything else being equal, on average, the more people we have the more money is used by them. So we divide the real M2 by the estimated monthly US population to get per capita, ‘real’ M2.
Then finally, we are interested in the annual rate of change that occurs in the real per capita M2 money supply, which gives us the chart you see.
The middle line represents zero, so anything above that means that the rate of change in money supply is positive and the Fed is pumping money into the economy (and vice versa). Obviously, the more extreme the move and the more the line stays above the 7 year moving average, the more significant it is.
From the latest data available (January 2009), the annual rate of change is higher than it has ever been - even higher than the early 1980’s. This means that eventually, as it works its way through the economy, there will be more and more money chasing fewer shares, driving up the level of the stock market.
Credit for this measure comes from an article by Norman P. Poiré, published in Barron’s on August 28th, 2000. If you aren’t a subscriber, you can read the article on Poiré’s website.
Barrons, bubbles, deflation, inflation, initial public offering, IPOs, M2, monetary policy, money supply, per capita, Poire, rate of change, real estate, sentiment, tech stocks
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5 Responses to “The Money Supply & The Stock Market”
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Doesn’t matter it seems, IF they choose to go down this path of monitizing our debt…
Our SPX, market, nation as whole, will be DEAD… FU**ED.. permanetly…
FISHER IS AN IDIOT! It doesn’t matter how “CAREFUL” you are doing this, once you start buying treasury, IT MEANS NO OTHER COUNTRY WANT IOU FROM US OF A ANYMORE! Which means we are FU**ED!
You inflation-adjusted the money supply? You must very strongly disagree with the school of thought that claims inflation is primarily caused by changes in the money supply. I think inflation adjusting the money supply is kind of like inflation adjusting oil inventories - completely useless mathematical analysis.
Also, it doesn’t make sense to try to adjust the money supply for population when determining how it will affect stock prices. If you want to claim that the money supply will affect stock prices, the most logical connection would be that increases in the money supply lead to increases in consumption, which leads to higher earnings and therefore a higher value for stocks. One of the reasons that stocks go up long term is that the population increases, which increases GDP and fair stock values. So I don’t think that adjusting for population is the right thing to do. If you agree with this line of reasoning, you will be better off looking at GDP data rather than M2, because there are a lot of other factors involved.
Anyway, the theoretical arguments don’t matter. According to your chart, the money supply was falling during most of the 90’s and growing all the time since 2000. Either there is a very long lag from changes in the money supply to changes in stock prices or else changes in the money supply (as adjusted here) don’t matter. If you want proof, do a regression analysis on your data vs stock prices. That graph isn’t useful for predicting changes in stock prices.
blues,
according to Bernanke:
“We expect growth in M2 to slow considerably in 2009,” he wrote. The Fed, he said, sees “little risk of unacceptably high inflation in the near term.”
jkw,
thanks for your suggestion. I’ll look into regression analysis. The original idea for this indicator comes from Poire I simply updated the chart to account for the most recent data.
Sure, money has to find a home somewhere.
Trouble is, it’s going to be finding a home in a mountain of debt.
We are nowhere near done deflating.
Thankyou for sharing this Good article.
Asolutely!
The current rally of stocks market, world-wide, are due to the acceleration of digital and paper money generation (money supply).
Share price of Companies with natural resources and necessity food production would raised at a speed directly proportional to the money printing press.
Bless You
KH Tang