Surging Liquidity: There's Money to Be Made Now

Yes, it will end badly. But in the meantime, there is a lot of money yet to be made. From Saturday's Wall Street Journal.

Worries are spreading that, like previous liquidity-driven market surges, this one could end badly, though many investors believe that won't happen soon.

Money supply in major countries, as measured by cash and checking accounts, has been rising sharply relative to gross domestic product, or total value of goods and services, Morgan Stanley reports. Money supply relative to GDP is at the highest level of any period covered by Morgan Stanley's data, which go back to the 1970s.

That measure of money supply has tended to move in line with bull and bear markets. It was declining in the late 1980s, ahead of the 1987 crash and the 1990 bear market. It started expanding in 1995, as a major bull market began. It started pulling back in March 2000, as the stock market fell. It then began expanding at the start of 2001, ahead of the next bull, only to top out again at the end of 2006, ahead of the next bear. Now it is surging again.

1100 on the S&P 500 anyone?

Comments

[Moon Kil Woong:]

We are less concerned with liquidity ending badly than starting badly. We are not out of the recession yet and inflation is rising along with commodities prices. Now Treasury yields are rising and the dollar is falling. If that's not badly I don't know what is worse. Just the fact we have to be talking about indflation at this point in the cycle is a very bad sign.

There may be money to be made, but what value it will inevitably have is looking questionable.

Jun 15 07:25 AM

[LilBob:]

Moon is right, we are not out of the recession yet. I think the Obama administration will pull back on the money supply as soon as the economy starts warming up again. It's really pretty simple-if there is too much liquid capital in the market for too long then prices will eventually spike and existing investments become relatively worthless, ergo-if the administration can use increased liquidity to spur the economy now, then start drawing down on said liquidity before consumers start building McMansions and buying $60,000 SUVs again, then there's a chance they may be able to keep things on balance.

Jun 15 08:57 AM

[Carl Spackler:]

One flaw in your reasoning is that all the above comparisons (of high money supply equals stock appreciation) involves our economy in a long term secular bull economy where consumers are in a long term movement towards spending. Essentially, consumers were almost always returning to a spend-crazy mood. This downturn is different. Consumers and businesses are hoarding cash and moving to a save first mentality. The collapse of the consumer's net worth caused by falling real estate and stock prices has caused everyone to re-evaluate their pending retirement. With the baby boomers now staring at a much more stark retirement and with this pending retirement coming very soon, this recession has caused them to move into full savings mode. This is a major development that will not be short lived. Expect for savings rates to remain high, and thus the amount of cash and checking deposits will also remain higher than normal.

Now, will some of this new savings show up in equities - yes, but this will be tempered by investor's long memories of previous stock losses over the last 18 months. A study of most asset bubbles found a very simple formula - that after a bubble pops, it takes 3 years to see positive appreciation return and ten years to see old highs revisited. This is because investors tend to shun asset classes that they have incurred large losses. The memory of their losses has to fade before they commit serious money at a previously failed investment. These two factors (higher savings rate and shunning of bubble assets) are markedly different than any time in the last 70 years. If you follow the old playbook on recessions this time, you may be in for a rude awakening!

Jun 15 12:00 PM

[jerrypan:]

I think the liquidity is from FED. Fake!

Jun 15 02:17 PM

[Alphameister:]

Notwithstanding the above comments, which fly in the face of the evidence, one of the oldest and most useful investment adages is: "Don't fight the Fed." The market is behaving just as the author suggests it should.

Jun 15 04:20 PM

[User 389132:]

Market is a fraud, GS buys for Gov't when volume weak...soon that won't work. SP 1100 in 2011, maybe.

Jun 16 12:31 AM