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The Money Supply & The Stock Market at Trader’s Narrative

The Money Supply & The Stock Market

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:
per capita money supply rate of change long term chart
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. PoirĂ©, published in Barron’s on August 28th, 2000. If you aren’t a subscriber, you can read the article on PoirĂ©’s website.

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7 Responses to “The Money Supply & The Stock Market”  

  1. 1 blues

    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!

  2. 2 jkw

    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.

  3. 3 Babak

    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.”

    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.

  4. 4 Dave Narby

    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.

  5. 5 KH Tang

    Thankyou for sharing this Good article.

    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

  6. 6 robert

    according to the way this M2 was calculated we should all run out and check the mail. because the idea that you should divide the money created by the population as though this country operated on a purely sociialist division of wealth where in all new money was divided according to NEED or a total head count surely has resulted in any more money available to be USED by anyone i know. a more correct calcualtion would ignore most ALL of the population, figure all that newly created money in the hands of the top 2 percent of the country (including banks) and then surmise that since they all had more money than they knew what to do with BEFORE that money was created and dumped into their hands, that its ALL available for investment. and since only a fool would put trillions in CD’s and real estate is crap these days, that would leave you with a truth that relects whats really happening since the mass creation of money started in 2009. -which is TRILLIONS have been created, the public got NONE of it (despite their needs) the wealthy (including banks) got ALL of it and needed NONE of it to live on, leaving that money with 0 reasonable places to go EXCEPT straight into the stock market. HENCE, even though the ECONOMY is still in the pits, and EVEN THOUGH europe is threatening to double dip the whole world, that stock market has gone up like a bottle rocket for the last 3 years as more and more EXCESS money keeps being created and given to folks who LEAST need it. take the straight unadulterated increase in money out there, plot it on a chart, and supper impose that stock market on top of it and you wont need to explain a thing. it will explain itself. —*but just in case im wrong and that money is being distributed on a per capita basis, I’m going to run out and check my mail, because SO FAR not a dime of its been sent to ME….

  7. 7 robert

    The one thing i have the hardest time fathoming is how so called experts keep insisting on attempting to figure the potential effect of newly created money on the stock market when the total amount of money out there has nothing to do with the market in and of itself. Stocks are purchased with EXCESS money, and only that should be figured in any equation. and NO its NOT true that if money is put in the economy and spent by people with NO excess money it will raise profits and therefor raise stock prices. i recall very well the DOW staying between 500 and 1000 and pes at 8 or under for 20 years, in fact the companies stocks were SOO undervalued corporate raiders came in and bought them, broke them into pieces and made BILLIONS -try that TODAY and you’ll loose your butt, which is WHY there are no corporate raiders breaking up companies they bought for a fraction of their worth anymore. the point is, if money falls into the hands of folks who desparately need it to pay debts and mortgages, NOBODY has the MONEY to buy stocks with. JUST AS It WAS in 1970s recessions. stocks are going up because the money to buy them with is ALL in the hands of the filthy rich bankers, and NOT the public who need it and wouldn’t spend it on stocks if you gave it to them. That money isn’t in the hands of the filthy rich isnt creating a single extra dime in consumer spending, the rich already HAVE all they want, so its not creating a nickels more earnings for american companies, yet they are buying stocks like crazy, so the idea that more money creates more spending that in turn raises profits that NECESSARILY raises stock prices and that THAT is how created money drives the stock market up -IS PURE BUNK. AS i pointed out, VALUE doesnt raise stock prices, BUYING pressure DOES. and THAT comes from ONE and only one source of money, EXCESS money available for investment. And since that money was INTENTIONALLY given to only the rich, it was ALL excess and therefor had a 1 to 1 correlation to stock buying pressure for every dollar created. -dollars that as i mentioned had NOWHERE else to go in this current no interest paying, real estate fearing, no growth economy we have now. no, the fed and its cronies wanted to save their preciious stock market, NOT the economy or the public, so they gave that money to folks who had to put it straight into that market. If you understand that simple equation, then youll understand why the fed KEEPS creating more money and placing it ALL in the hands of folks who MUST in turn put it straight into the market, then you’ll be able to correctly predict this markets direction going forward. Youll also understand why big business and the republicans fight tooth and nail with Obama every time he suggests putting some of that money DIRECTLY into the economy its supposed to be headed for anyway, because its NOT designed to help the economy or the people and they don’t WANT it to help them, they want it to help THEMSELVES and their stocks.

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