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US equity market still running on empty

Posted by Tim Congdon in Article Archive | 0 comments

In my e-mail note of 8th April I argued that the bull market was “running on empty”. The argument was that the nominal level of equity prices could be viewed as the product of

  1. The quantity of money allocated to equity funds by investors, and
  2. ii. Equity fund managers’ desired ratio of money to their total assets (i.e., their “bullishness” or “bearishness”, or indeed their “liquidity preferences”, as Keynes would have put it).
(This formulation was a little naive and begs many questions, but it gets the ideas over.) My worry in that note was that in the USA the bull market from March 2009 had depended almost entirely on a fall in fund managers’ desired ratio of money to assets (i.e., on medium-term bullish sentiment). Money growth had been negligible at best since early 2009. On some measures – such as the old “M3”, no longer published by the Fed, but easily enough guesstimated – the quantity of money had in fact started to fall in late 2009. Since peaking in late April, most equity markets (including the US market) are off by about 10% and are lower than at the time of the 8th April note. Of course many other factors influence the direction of markets, with alarm about the potential break-up of the Eurozone certainly being a major negative at present. However, I thought it worthwhile in this weekly e-mail to update the numbers in the 8th April note. The main point is straightforward, that the US banking system remains gripped in a regulatory vice which has stopped it from expanding. M2 is going sideways, while M3 – which consists of M2 plus other money balances (notably the “institutional money funds” which are the main form of cash for the USA’s long-term savings institutions) – continues to fall. So the US equity market is still “running on empty”. Perhaps most worrying of all, there is little evidence that the Federal Reserve’s research effort pays much, if any, attention to the money trends which I have been analysing.  

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