Alan's Alert 7-28-2021

 

After yesterday’s money stock report, I thought I should take some time to review previous money stock reports in a hope that it would shed a little light on the current situation.

 

The reason that the money supply report is so important is that it signifies whether money is plentiful or scarce.  When money is plentiful, it is able to bid up the prices of goods in the capital goods sectors.  The most liquid capital goods sector is the stock market, followed closely by the bond market.  Housing is also a capital goods sector but is less susceptible to fluctuations in the money supply reports.  This is due to the fact that when people buy a house, they tend to stay in that house for a long period of time.  Also, when you go to sell a house, it typically takes many weeks.  Once a buyer and seller come together on an agreed upon price, the banks get involved.  Most people require a mortgage; hence a bank has to be brought in on the transaction.  Once the bank gets onboard, a real estate closing can run up to 60 days before it gets finalized.  This makes housing much less liquid.  When people (or corporations, hedge funds, pension funds, etc.) own stock, they can quickly and easily sell it.  Prices can quickly fluctuate to find an equilibrium between buyers and sellers.  This makes owning stock more liquid.  The same goes for the bond market.  Since there is a large pool of buyers and sellers, equilibriums are found quickly.  When money becomes scarce, there are fewer buyers.  When there are more sellers than buyers, the price must come down to find the equilibrium. 

 

This brings me to Alan’s trading rule #1; for every buyer, there must be a seller.  When you are buying a stock, option contract, futures contract, or bond, someone is on the other side of that trade selling it to you.  I think this idea gets forgotten in our world of online brokers and market maker liquidity.  Do you think that person selling you that stock made money before they sold it to you?  Do they expect the price to go down, is that why they sold?  What makes you think that you know more than they do?

 

Our first foray into the adventures of money printing, is a look back to the 07-08 financial crisis.  One of the first clues that signified there would be an issue was that the yield curve had gone negative.

After the yield curve goes negative, banks struggle to make money.  When banks issue loans, they borrow money on a short-term basis and lend it out on a long-term basis.  When the yield curve goes negative, banks lose money on new loans.  Since the US operates on a fractional reserve system, banks only need a fraction of the funds necessary to create new loans.  This means that the banks can loan out money they don’t have.  This expands the money supply.  Once new loans aren’t issued, the banks stop expanding the money supply. 

 

This is what the money supply looked like from 2004-2008.  You can see that there is a seasonality to the flow.  It looks like a series of waves.  It starts high at the beginning of the year, drops slightly, rises, drops further, then rises, plateaus, then rises again to end the year.  2008 is in yellow with the blue boxes.  You can see that year looks quite different than the rest.  It started similarly to other years but then rose much higher.  It peaked at 16% on week 17.  After this high rise, it then plummeted lower than any other year.  My calculation of the money supply actually put it at a negative amount for 5 straight weeks, bottoming at -3% on week 30.

This caused havoc in the S&P500.

I’ve pointed out the specific weeks that were highlighted in the money supply chart with the high (week 17) and lows (week 27 and 30) on the S&P500 chart.

On week 17, the S&P closed at $138.55.

On week 27, the S&P closed at $128.04.

On week 30, the S&P closed at $126.13.

At the beginning of Sept, the S&P closed at $127.99, but then the plunge began. By the beginning of Oct, $115.99 (down 9% month-over-month).  By the beginning of November, $96.83 (down 17% month/month).  By the beginning of Dec, $82.11 (down 15% month/month).

There were many other factors that fueled the 07/08 financial crisis but the money supply data told the tale of the tape for the S&P500.  There was about an eight-week lag between the low of the money supply data and the beginning of the stock market crash.

 

 

 

Our next adventure in money printing takes us back to 2000-2002.  Again, the first clue that something was going wrong was spotted in the yield curve.

The curve had been dragging bottom for a long time, but once it went negative, the stage was set.

 

 

The money supply curve looks similar to the earlier example.  We have a wave to start the year, then a lull, a peak, then a trough, it then climbs to a plateau before it ramps up at the end of the year.  I put a red box around weeks 36-47 in 1999.  This was a lower plateau than previous years.  It also lasted longer.  This was a hint that choppy action for the market was dead ahead.  We then moved into the year 2000.  I’ve used orange arrows to highlight the peak and trough.  The peak in 2000 was achieved on week 18 and was higher than the previous two years.  It then plunged below the trough trendline and went negative by week 27.  Its plateau was similar to the previous year which was not enough to push the market higher.  By 2001 the Fed tried to juice the money supply.  It started off the year hot, rising to a peak on week 16 of 17.5%.  It then dropped off to a low of -1.7% in week 29.  The entire year of 2002 was sluggish.  The money supply was below the trendline by week 11 but the trough was shallow.  It then plateaued higher than 1999 & 2000.  This helped to stabilize the market.

 

Approximately 8 weeks after the red box in 1999, we had choppy action in the stock market.  There was a push to a higher range.  Then, 8-10 weeks after the negative money supply data on week 27 in the year 2000, the crash began.  The market never stabilized until 10 weeks after the money supply's high plateau in 2002.

 

 

While our current situation is similar to both of these instances.  There is one glaring difference.  That is the yield curve signal. 

 

While it did run negative in the summer of 2019, it was not nearly as long or deep as the previous two instances.  Tomorrow I’ll expand our adventures in money printing to look at instances where the yield curve didn’t go negative and we had a slow down in the money supply.  I believe that the current phase of the economy will be more in line with those instances and give us a better look into what we are dealing with.