Change in the S&P 500 Lags Change in the Monetary Base

[twacowfca]

This composite graph, from January 7, 2009 through last Friday, April 23, 2010, shows how change in the S&P 500 has lagged change in the monetary base (WSBASE) by a few weeks.  The recent sustained decline in the WSBASE prompted us to hedge most of our portfolio in the last few days by increasing cash and buying S&P 500 puts.

[beerbaron]

I'm not used to analyze macros, so can you explain further what it implicates that the money supply has decreased? Does it mean that the deleverage is still happening?

 

BeerBaron

[twacowfca]

I'm not used to analyze macros, so can you explain further what it implicates that the money supply has decreased? Does it mean that the deleverage is still happening?

 

BeerBaron

 

 

In the wake of the financial crisis, the government doubled the monetary base, mainly by increasing reserves in the banking system. That has never happened before to such a degree.  The monetary base part of the money supply has the most immediate affect on the financial markets, providing the basis for  increasing liquidity, lending etc.  The recession has now ended and credit may soon be starting to flow in an increasing stream.  this will accelerate to an unsustainable rate as if the floodgates were opened if there isn't a reduction in the monetary base in the not too distant future.  However, the recent downtick in the monetary base may be temporary because The fed has said that they will keep interest rates low for most of this year.  Nevertheless, there is so much surplus that it may be possible to reduce the base without risking another recession as the velocity of money now seems to be increasing. If you can predict exactly when this will hit the markets with full force, you're a better man than I. When this happens, it will not exactly be bullish for the stock market.

[beerbaron]

Thanks a lot.

 

BeerBaron

[twacowfca]

The S&P500 and other equity

markets are now closely tracking the recent downward reversal in the trend of the monetary base after the usual lag of a few weeks.  I'll post an update of the composite graph tomorrow.

[twacowfca]

Here's the latest update of the composite WSBase/S&P500 graph as promised last night.

 

Twacowfca

[Rabbitisrich]

Twacowfca, is this relationship conditional? Do you have an expectation of when the correlation breaks down?

 

From the chart you provided, a ~15% change in the monetary base resulted in a ~24% change in the S&P, which doesn't seem to be sustainable.

[twacowfca]

Twacowfca, is this relationship conditional? Do you have an expectation of when the correlation breaks down?

 

From the chart you provided, a ~15% change in the monetary base resulted in a ~24% change in the S&P, which doesn't seem to be sustainable.

 

 

 

Yes, it is conditional.  Generally, with a long term view, there is a high, positive correlation with a short lag.   However, in very bullish or bearish markets, the market can take on a life of its own and shrug off the trend of the monetary base or greatly accentuate the trend.

 

The recent high correlation of the monetary base and the S&P500 as the market has risen steeply suggests that this has not been a bull market, but rather a recovery dependent on the unprecedented  monetary stimulus.  If so, the market may be very sensitive to declines or even flattening out of the moving average of the monetary base.

[Rabbitisrich]

Thanks for the reply.

[twacowfca]

We got the latest weekly update of the WSBASE at 11:30AM today showing the second weekly increase in the monetary base. Therefore, we sold all of our S&P 500 puts for nice gains, averaging about 5 X .  This action is not based on a prediction that the market has necessarily found a bottom.  In fact, bearish animal spirits can overwhelm the monetary trend.  However, spikes in volatility are usually fleeting, and recent history shows that the market has turned up two to four weeks after a downward trend in the monetary base  has reversed and turned up.

 

TWACOWFCA  :)

[onyx1]

 

 

Thanks for posting Twacowcfa.  I was on the fence about buying some protection right before the FFH meeting, and your graph was the final catalyst.  Bought SPY puts and sold them a week ago 7x the price I paid. 

 

Best,

 

onyx

[bargainman]

We got the latest weekly update of the WSBASE at 11:30AM today showing the second weekly increase in the monetary base. Therefore, we sold all of our S&P 500 puts for nice gains, averaging about 5 X .  

TWACOWFCA  :)

 

TWACOWFCA, where do you get the WSBASE information from?  Is this your own custom PDF/XLS graph, or is it available publicly?

 

Thanks,

bargainman.

[twacowfca]

 

 

Thanks for posting Twacowcfa.  I was on the fence about buying some protection right before the FFH meeting, and your graph was the final catalyst.  Bought SPY puts and sold them a week ago 7x the price I paid. 

 

Best,

 

onyx

 

 

You're very welcome.  Glad the graph was helpful. 

[twacowfca]

We got the latest weekly update of the WSBASE at 11:30AM today showing the second weekly increase in the monetary base. Therefore, we sold all of our S&P 500 puts for nice gains, averaging about 5 X .  

TWACOWFCA  :)

 

TWACOWFCA, where do you get the WSBASE information from?  Is this your own custom PDF/XLS graph, or is it available publicly?

 

Thanks,

bargainman.

 

It's our composite graph.  The data is published weekly by the St. Louis Fed, usually on Friday before noon.  :)

[twacowfca]

Here is the latest update showing how the change in the S&P 500 continues to track the change in the monetary base fairly closely with a certain amount of lag.

[bargainman]

Really interesting.. Thanks for posting this.  Looks like WSBase has gone down a bit more but not too drastically.  Would love to see this when WSBase makes a drastic move up or down...  :-)

[Zorrofan]

Here is the latest update showing how the change in the S&P 500 continues to track the change in the monetary base fairly closely with a certain amount of lag.

 

Twacofca,

 

Are you using the movement of the WSBase to predict the general market direction? Is this not similar to using the old M3 to try and predict a downturn in the economy? roughly what is the lag between the WSBase and S & P movement?

 

thanks for a most interesting post!

cheers

Zorro

[twacowfca]

Here is the latest update showing how the change in the S&P 500 continues to track the change in the monetary base fairly closely with a certain amount of lag.

 

Twacofca,

 

Are you using the movement of the WSBase to predict the general market direction? Is this not similar to using the old M3 to try and predict a downturn in the economy? roughly what is the lag between the WSBase and S & P movement?

 

thanks for a most interesting post!

cheers

Zorro

 

 

The money supply does affect the economy and credit markets and the stock market.  Changes in the monetary base have the quickest effect.  Most of the time in recent decades with slight movements in the monetary base the association is almost imperceptible.

 

 Before the creation of The Fed, the arrow of causality often went both ways.  Fiscal policy would increase or decrease the money supply, but banking panics would have the most drastic effect and rapidly drain the reserves in the banking system, the key part of the monetary base, sometimes almost overnight.

 

The 2008 financial panic was so severe that The Fed took unprecedented action and doubled the monetary base within a few weeks.  The lines of the graphs of the stock market and the monetary base crossed each other, one like a rocket ship going almost straight up, the other like a VII rocket falling on London.  If a naive statistician looked at that short section of the series and extrapolated from it, he might erroneously conclude that the change in the monetary base lagged the change in the stock market and that the correlation was strongly negative!  In truth, this action more than any other type of stimulus, saved us from another Great Depression.

 

The stock market has exhibited great sensitivity to changes in the monetary base since then, as shown on the updated graph.

 

The lag during the last 18 months has been from two weeks to two months before the market has turned down by an appreciable amount after a downward change in the monetary base, but the lag has been generally no more than about 4 weeks  before an upturn in the monetary base is associated with a reversal in a downward direction in the S&P 500.  I personally don't think it's a sure thing that a reversal of a decline in the monetary base by the Fed will always be able to arrest a decline in the stock market.  If the market should generate a sufficient amount of downward momentum, the stampede over the cliff might become irresistable.

 

 

 

 

[link01]

broad based US stock indexes correlate pretty well in the aggregate with global stock indexes as well. have you ever plotted the relationship between the wsbase of some of the major european countries & their stock indexes...& found that relationship to be universal? if so then you would expect to see a high degree of correlation in the wsbase movement of all the major economies, similar to their stock market correlation. if not then.....someone's got some fancy theoretical 'splaining to do.

[twacowfca]

broad based US stock indexes correlate pretty well in the aggregate with global stock indexes as well. have you ever plotted the relationship between the wsbase of some of the major european countries & their stock indexes...& found that relationship to be universal? if so then you would expect to see a high degree of correlation in the wsbase movement of all the major economies, similar to their stock market correlation. if not then.....someone's got some fancy theoretical 'splaining to do.

 

 

Generally, the US is the 400 pound gorilla in the international monetary system.  Very few countries are not affected by what happens in the US, but sometimes the US and other highly developed countries can shrug off what happens in developing countries.

[twacowfca]

During the last two years, the U.S. stock market has been very sensitive to changes in the monetary base, the “high powered money” part of the money supply.  The sharp decline in the WSBASE earlier this year preceded and likely precipitated the sharp selloff in the market late this spring.  Since then, the WSBASE has stabilized and stock market volatility has dampened down.

 

However, the very slight recent downward trend could be a little bearish if continued after the U.S. Congress returns for business September 13, 2010.  Congress being in session in turbulent times is a big negative predictor for stock market prices. 

 

[twacowfca]

broad based US stock indexes correlate pretty well in the aggregate with global stock indexes as well. have you ever plotted the relationship between the wsbase of some of the major european countries & their stock indexes...& found that relationship to be universal? if so then you would expect to see a high degree of correlation in the wsbase movement of all the major economies, similar to their stock market correlation. if not then.....someone's got some fancy theoretical 'splaining to do.

 

 

The relationship holds strongly in other markets.  Please see the recent posting by rick_v  in the Japanese Research as Promised thread.  In his graphs, one can see how the acceleration in the growth of the Yen M2 money supply supported the stock market bubble, and then how the sudden slamming of the brakes on the growth of the money supply precipitated the crash and influenced the steep decline.  When a large bubble develops, markets become exquisitely sensitive to small changes.  It doesn't take much to prick a bubble that's about to pop.

[beerbaron]

Money Supply took a 60B drop this week what do you think twacowcfa?

 

 

BeerBaron

[twacowfca]

Money Supply took a 60B drop this week what do you think twacowcfa?

 

 

BeerBaron

 

Thanks for the update.  That's a sharp drop.  There's been a lag of about 3 to 6 weeks from a sizable downturn in the WSBASE to a sizable drop in the market.  I would be concerned if there is another big drop next Friday.  We'll keep a close eye on it.

 

Once again, many thanks. We've been out of town the last few days.

[Zorrofan]

Since it has been a while since we last looked at this, here are the latest figures available....

 

Date  2010-09-08  2010-09-15  2010-09-22  2010-09-29  2010-10-06 

Value  1987.560    1981.602      1928.937    1949.490    1943.934 

 

 

Anyone looking at adding some hedges at this point, I know I am considering it?

 

cheers

Zorro