The Stock Market and Economic Data
In previous articles we have occasionally discussed the interaction between economic indicators and the stock market. Among the topics we have touched upon: for one thing, the capitalization-weighted indexes can hardly be called “leading indicators” of the economy anymore. In fact, if one studies specific major turning points over the past two decades or so, it is clear that the market seems to “know” very little (at least not in advance).
The impression one gets is actually that the major indexes are acting like coincident rather than leading indicators of the economy. However, the market is not completely bereft of leading indicator qualities. What seems to be leading the economy are not the cap-weighted indexes, but market internals.
We believe we can explain why this is the case. In an economy in which the money supply can be expanded ex nihilo by central planners and/or commercial banks, the pace of money supply growth tends to lead both stock market returns and the performance of the economy as measured in terms of aggregate data.
Readers may have noticed our habit of adding the qualifier “as measured by aggregate data”. We are doing this because the boom period is a kind of Potemkin village: seemingly busy economic activity and surging accounting profits are masking the fact that a great deal of capital is consumed. Simply put, accounts are falsified, because loose monetary policy distorts and falsifies the entire economy’s price structure.
Due to the modus operandi of central banks and the growing popularity of all sorts of financial engineering strategies, financial asset prices are these days the greatest beneficiaries of monetary inflation. Once the pace of inflation begins to slow down, a difficulty presents itself that is first noticed in financial markets. The reduced flow of additional money means that parts of the bubble have to be abandoned – there is no longer enough “juice” to lift all the boats.
An internal shift takes place at that point: investors begin to sell less liquid stocks and move their funds into liquid big cap stocks, preferably those with a good “growth story”. We have seen yet another example of this behavior last year: already extremely overvalued big caps (i.e., the so-called “FANGs”) advanced strongly, while the vast majority of stocks came under varying degrees of pressure at the same time. The result was a sideways move in the popular indexes which superficially suggested that everything was fine, while large swathes of the market crumbled underneath the tranquility.
Another topic we discussed was the fact that the yield curve loses part of its traditional signaling function once a zero interest policy has been adopted. In short, one can no longer rely on a yield curve inversion to warn of impending trouble in the stock market and the economy. A mere flattening of the curve is likely all one is going to get (see “The Yield Curve and Recessions”, where we inter alia showed a chart of Japan’s yield curve and recessions since the late 1980s).
One interaction we have mentioned a few times is the pronounced inverse correlation between the stock market and initial unemployment claims. John Hussman discusses initial claims in this week’s market report, mainly in connection with their usefulness as a recession indicator (and by inference, a stock market indicator). He mentions an interesting empirical datum in this context:
“On the economic front, I continue to believe that a U.S. recession is not only a risk, but is now the most probable outcome. As I noted last week, among confirming indicators that generally emerge fairly early once a recession has taken hold, we would be particularly attentive to the following: a sudden drop in consumer confidence about 20 points below its 12-month average (which would currently equate to a drop to the 75 level on the Conference Board measure), a decline in aggregate hours worked below its level 3-months prior, a year-over-year increase of about 20% in new claims for unemployment (which would currently equate to a level of about 340,000 weekly new claims), and slowing growth in real personal income.
Last week, new claims for unemployment jumped to 293,000, a level we’ve observed only once since last April. Even at this early point (given that employment measures are among the most lagging economic indicators), we already observe a pickup in claims from last year’s lows. To put this increase into perspective, the chart below shows points where the ISM Purchasing Managers Index was below 50, the S&P 500 was below its level of 6 months prior, and the 4-week average of initial unemployment claims was at least 5% above its 12-month low. While a year-over-year increase in unemployment claims closer to 20% would be a more reliable confirmation of recession, it’s clear that even here, the current combination of evidence is more associated with recession than not.”
Here is a chart illustrating the inverse correlation between the S&P 500 Index and initial claims:
Initial claims and the SPX: major turning points in claims are highlighted in blue, and major turning points in stocks in red. These tend to be very close together – 2001/2 was an exception, but even on that occasion interim peaks and troughs showed close alignment. Note: in 2007, claims made a secondary low concurrently with the stock market’s peak, while the initial slightly lower low in claims in 2006 occurred fairly close to the peak of the housing boom (there was brief spike due to hurricane Kathrina in 2005 one has to ignore as exogenous) – click to enlarge.
The next chart shows a close-up of initial claims over the past year. The current level does not yet appear to be a decisive signal (as Mr. Hussman mentions, in the past a 20% surge off the low usually coincided with the beginning of recessions), but a trend change could well be underway:
We would say that while the trend change is not yet firmly established, this does look a bit suspicious – especially in light of assorted economic data releases over the past few months and the recent behavior of the stock market.
The Monetary Backdrop
Given the central role money supply growth is playing in driving the boom-bust cycle, one needs to keep a close eye on it. The broad money measure TMS-2 has recently been updated to December, and it can be seen that there has been a notable spike over the past two months – which has driven the year-on-year growth rate back up to a hefty 8.45%.
The main drivers of this spike are the Treasury’s general account with the Fed, which has increased rapidly since the end of October. We are not sure why it has been growing so fast of late, but will report back if we manage to find out. The other driver was a year-end spike in demand deposits – which has since then been given back, see also the comments on M1 further below.
US broad money supply TMS-2 – a spike in November-December 2015. The treasury’s general account has been rising strongly since the end of October, and in December demand deposits also rose sharply (at a 15% y/y rate) – click to enlarge.
A similar year-end spike occurred in the narrow money measure M1 as well (due to the sudden surge in demand deposits). While we aren’t entirely sure, it seems quite possible that year-end balance sheet window dressing activities by banks and/or MMFs, or other businesses may have something to do with these gyrations (a similarity to the big surge in year-end reverse repo transactions). These may for instance involve temporary repatriation of dollars held in accounts abroad, which would certainly tend to add to the domestic money supply.
M1 is reported quite timely on a weekly basis, and in early January its y/y growth rate has fallen back to the low end of its recent range, which cements this suspicion (demand deposit growth fell from 15% y/y at the end of December to 5% as of mid January). A similar move will likely be visible in TMS-2 once the next update including January becomes available (some of its components are only updated monthly with a three week lag).
We intend to replace M1 with charts of TMS-1 and AMS soon, but for a quick look at the portion of the money supply that consists primarily of what we would term “transactional money”, M1 will actually do for now. A large component of TMS-2 consists of savings deposits, on the grounds that they are de facto redeemable for standard money (banknotes) at par on demand, but these deposits are obviously far less often used in transactions than demand deposits (a side note: M1 also includes traveler checks, which are clearly not money, but the amount is by now so tiny that it can basically be ignored).
Here is a chart of the y/y M1 growth rate – as can be seen, the overarching downtrend remains firmly in place:
Narrow money growth is likely to lead TMS-2 growth and its decline from a nearly 25% growth rate at the 2011 peak to less than 6% today strikes us as quite significant. It does indeed appear as though the bubble is “running out of juice”.
The same is not true in the euro area (TMS growth of +14% y/y), but as we have previously pointed out, we believe US money supply growth rates to be more important for global asset prices, due to a variety of feedback effects (recent developments in global stock markets seem to be confirming this so far).
Initial claims are creeping closer to the level at which they will give both a recession and a bear market signal. These data should be watched very closely over coming weeks. The stock market has already given a number of signals typically associated with a major trend change (apart from market internals, there is e.g. also the ominous peak in margin debt on April 2015, which hasn’t been exceeded since).
Lastly, although TMS-2 growth has re-accelerated after seemingly breaking down last October, this seems mainly due to one-off effects, some of which are reversing already. Narrow money growth has already slowed a great deal more, and the late December spike was evidently a fluke. Once money supply inflation slows sufficiently, all bubble activities are doomed.
Charts by: StockCharts, St. Louis Federal Reserve Research
It is that time of the year again – our semi-annual funding drive begins today. Give us a little hand in offsetting the costs of running this blog, as advertising revenue alone is insufficient. You can help us reach our modest funding goal by donating either via paypal or bitcoin. Those of you who have made a ton of money based on some of the things we have said in these pages (we actually made a few good calls lately!), please feel free to up your donations accordingly (we are sorry if you have followed one of our bad calls. This is of course your own fault). Other than that, we can only repeat that donations to this site are apt to secure many benefits. These range from sound sleep, to children including you in their songs, to the potential of obtaining privileges in the afterlife (the latter cannot be guaranteed, but it seems highly likely). As always, we are greatly honored by your readership and hope that our special mixture of entertainment and education is adding a little value to your life!
Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke
One Response to “Stocks, the Economy and the Money Supply – What to Watch”
Most read in the last 20 days:
- A Striking Chart
The Economy and the Stock Market As long time readers know, we are always paying close attention to the manufacturing sector, which is far more important to the US economy than is generally believed. In terms of gross output it is the largest sector of the economy, and it should of course be obvious that saving, investment and production are the only ways to create wealth. What's left of the Brooklyn Domino Sugar Refinery. Photo credit: Paul Raphaelson Contrary...
- Trump and Putin Narrowly Escape Assassination Attempt
The Gloves are Coming Off First a little bit of recent history. Readers are probably aware that some questions about the occasionally malfunctioning Deep State android... no, wait, we'll start again. Questions have recently been raised about the health of presidential candidate Hillary Clinton by various “alt-right” tinfoil hat-wearing conspiracy theorists, such as this one. The monsters are normally hiding under Hillary's bed, but lately they have come out into the open...
- US Economy - Curious Pattern in ISM Readings
Head Fake Theory Confirmed? This is a brief update on our last overview of economic data. Although we briefly discussed employment as well, the overview was as usual mainly focused on manufacturing, which is the largest sector of the economy by gross output. Pepsi factory in Baltimore, 1956 Photo via pinterest.com Readers may recall that we have pointed out for some time that there was quite a large gap between the data reported in regional Fed manufacturing...
- Why the Fed Destroyed the Market Economy
What Have You Done for Me Lately? Swing voters are a fickle bunch. One election they vote Democrat. The next they vote Republican. For they have no particular ideology or political philosophy to base their judgment upon. The primacy of the wallet. They don’t give a rip about questions of small government or big government. Nor do they have any druthers about the welfare or warfare state. In effect, they really don’t care. What’s important to the...
- How is Real Wealth Created?
An Abrupt Drop Let’s turn back to our regular beat: the U.S. economy and its capital markets. We’ve been warning that the Fed would never make any substantial increase to interest rates. Not willingly, at least. Groping in the dark, Yellen-style Each time Fed chief Janet Yellen opens her mouth, out comes a hint that more rate hikes might be coming. But each time, it turns out that the economy is not as robust as she had believed... and that a rate hike isn’t...
- Janet Yellen’s Shame
Playing Politics In honest capitalism, you do what you can to get other people to voluntarily give you money. This usually involves providing goods or services they think are worth the price. You may get a little wild and crazy from time to time, but you are always called to order by your customers. In the market economy, consumers reign supreme. There is no such thing as a “lost” vote in the marketplace; every penny spent affects production. Mises noted: “Consumers...
- Get Ready for a New Crisis – in Corporate Debt
Imposter Dollar OUZILLY, France – We’re going back to basics here at the Diary. We’re getting everyone on the same page... learning together... connecting the dots... trying to figure out what is going on. The new three dollar bill issued by the Apprehensive States of America. We made a breakthrough when we identified the source of so many of today’s bizarre and grotesque trends. It’s the money – the new post-1971 dollar. This new dollar is green. You...
- The Economy, the Stock Market and the Fed
John Hussman on Recent Developments We always look forward to John Hussman's weekly missive on the markets. Some people say that he is a “permabear”, but we don't think that is a fair characterization. He is rightly wary of the stock market's historically extremely high valuation and the loose monetary policy driving the surge in asset prices. The S&P 500 Index and the NYSE advance-decline line. Most market internals weakened steadily until early February 2016, but...
- Hanjin Marooning in San Pedro Bay
Global Trade Reversal Expansions and contractions in global trade have played out over long secular trends for thousands of years. The Silk Road, for example, was established by the Han Dynasty of China in 130 BC, and allowed for continuous trade between East and West for nearly 1,600 years. In addition to economic trade, the Silk Road was also a conduit for culture and knowledge among its network of civilizations. A map of the main ancient Silk Road - click to...
- Great Causes, a Sea of Debt and the 2017 Recession
Great Cause NORMANDY, FRANCE – We continue our work with the bomb squad. Myth disposal is dangerous work: People love their myths more than they love life itself. They may kill for money. But they die for their religions, their governments, their clans... and their ideas. Famous French hippie and author Voltaire. He wears the same sardonic grin in every painting, whether he's depicted at a young or an old age, doesn't matter. His real name was François-Marie Arouet; he...
- The Donald Versus Killary: War or Peace?
War: A Warning from the Past Although history does not exactly repeat itself, it does provide parallels and sometimes quite ominous ones. Such is the case with the current U.S. Presidential election and the one which occurred one hundred years earlier. The Donald probably has the better slogan... The dominating question which hung over the 1916 campaign was whether the country would remain neutral in regard to the horrific slaughter which was taking place on the...
- A Rift in the Space-Time Continuum
Weird and Unnatural NORMANDY, France – First, a quick look at the markets. The Dow bounced on Monday, recovering 239 points of the nearly 400 it lost on Friday. Why the comeback? FOMC member Lael Brainard: her comments on Monday were touted as the “reason” for the stock market recovering half of Friday's losses. We suspect the real reason is the triple witching on Friday... Photo via twitter.com The financial press has a ready answer: “Stocks gain...