Stocks On A Monetary Leash

Stunning to see the weekly monetary aggregates (M2) continue to grow at an unprecedented 25 percent year-on-year rate.  Not so stunning to see the stock market mania being led and fueled by the money supply growth.

Yet, it is stunning, actually frightening, to see stocks need the 25 percent money growth to sustain its momentum.   This is unprecedented and unsustainable as inflationary pressures are and will surely continue to build even in the flawed official measures.

The stock market’s momentum must continue or else.

“There Is No Plateau, No Middle Ground”

The economic situation in a country after several years of bubblelike behavior resembles that of a young person on a bicycle; the rider needs to maintain the forward momentum or the bike becomes unstable. During the mania, asset prices will decline immediately after they stop increasing—there is no plateau, no ‘middle ground.’ The decline in the prices of some assets leads to the concern that asset prices will decline further and that the financial system will experience ‘distress.’ The rush to sell these assets before prices decline further becomes self-fulfilling and so precipitous that it resembles a panic. The prices of commodities—houses, buildings, land, stocks, bonds—crash to levels that are 30 to 40 percent of their prices at the peak. – Charles Kindleberger 

S&P500 And M2 Money Weekly Year-on-Year Growth 

Inflationary Pressures Building 

We closely follow the manufacturing industry, especially the electronics sector, where inflationary pressures are increasing dramatically.

This from the latest global PMI. Some hoarding is actually breaking out in various sectors as producers are expecting higher input prices due to continued supply chain issues and strong demand.

Watch especially semiconductors.  Recall our post on how the long secular deflation in semiconductor prices may be coming to end.

we believe has been one of the largest factors, along with globalization to the disinflationary forces over the past 30 years. That is the secular decline in the price of semiconductor prices.  Semiconductors are the basic building block of today’s economy, as was oil during the industrial revolution.  – GMM,  Oct 2020

Inflation Expectations 

Inflation expectations are also rising across the board.

Stocks and corporate bonds aren’t the only markets that have been looking past the pandemic—the bond market’s gauge of inflation expectations has strengthened back to pre-Covid levels as well. – Barron’s

Surprised? 

After all,

Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output. – Milton Friedman

The FED 

We sense the Fed governors sense and are concerned about all of the above and reluctant to continue “carpet bombing” the economy with more monetary stimulus.

Federal Reserve Bank of Chicago President Charles Evans said Friday that although the latest job creation data is disappointing, he wasn’t yet ready to call for changes in central-bank monetary policy. – WSJ, Dec 4th

The economy as a whole is running pretty hot (GDP Now at 11.1% Q4 print) and even though the latest lockdowns as COVID cases spike could slow things a bit, economic output should be close to fully recovering its losses from the Q4 2019 peak by year-end.

Two Economies

It is better to think about the A Tale of Two Economies, the super-hot economy, which has benefited from the COVID crisis, and the depressed economy, such as travel and hospitality, where employment is still 20 percent below February 2020 levels vs -6.2 percent for total nonfarm jobs.

Labor Market Lagging Economic Rebound 

The following chart illustrates the labor market is significantly lagging the economic recovery.  Not uncommon but the distance between the two economic indicators is a bit of an anomaly.

It’s unlikely the FED is going to slam on the breaks but it does sound they are growing concerned that there is too much stimulus in such a hot economy.

Cruise Missiles, Not Carpet Bombing

We believe economic policymakers will have to resort to strategic strikes on the weak pockets of the economy by bringing out the cruise missiles of targeted fiscal rather than using the blunt tools of monetary policy.  Using monetary policy to fine-tune an economy is tantamount to threading a needle with boxing gloves on.  Good luck with that.

A 25 percent growth rate in the monetary aggregates is clearly not sustainable but if the stock market is addicted to the liquidity, which is driving its forward momentum.   Therein lies the rub, folks.

We don’t see a way out and expect the term “inflation” to come back into the lexicon of the market geniuses much sooner than most think.

A further issue to consider is given the substantial imbalances that have built up in the economy and financial market over the years,  there is no middle ground on the inflation spectrum but only what economists call a corner solution.   That is lots of inflation or deflation.

What is going to happen to the stock market, for example,  if the Fed moves back to a normal monetary policy with the monetary aggregates growing at their normal rates of, say, 5-8 percent year-on-year?   What if the Fed has to keep the monetary spigots on to keep the asset markets afloat?  It doesn’t take a rocket scientist to see the rabbit hole the monetary authorities have descended in to.

The Carol K. Provisio 

Finally, we do have to give a shout out to Carol K.,  GMM’s crack stock picker, noting what she has pounded into us in 2020 — that the stock market is a market of stocks and some stocks, especially the tech stocks of the future, are in a secular bull market.  We are thankful that she is on board and acts as a check on our natural contrarian tendencies to bet against the market.

Permabulls automatically bat .700 as the stock market has risen 72 percent of the time on an annual basis over the past 70 years.  That’s too easy.