It's no secret that U.S. equities markets have seen their values drained at record rates since the start of the year. With the S&P 500 down 7.96%, the DJIA down 8.09%, and Nasdaq down 10.59% in just under 20 days, with all of these indexes now preparing to break through significant support levels, many are reasonably worried about what's coming next.
Plenty of ideas have been tossed around for why traders suddenly decided to run for the hills at the turn of the year. Popular opinions for the fall include fears about a Chinese slowdown, negative effects of depressed oil prices on the economy, a strong Dollar hurting exports, and rising interest rates adding unnecessary drag to an economy that was weaker that expected. While all of these factors probably are having an effect on the economy and, in turn, financial markets, I'd like to put forward another possibility that seems to come up much less often.
The MZM (Money Zero Maturity - M2 without time deposits) money supply, which is a measure of money immediately available for transactions, has nearly doubled since 2007. Despite this, prices have only risen about 16% since that time. It is unlikely that all of this money is simply not being spent by businesses and consumers. In fact, the American consumers has proven extremely resilient.
What I believe to be happening is that a significant portion of this money is not actually going into the general economy. Instead, the financial system, which is responsible for disseminating this money through loans, isn't functioning correctly under such exceptionally low rates. These rates are dissuading lenders, who are instead chasing the returns of riskier financial assets with less economic benefit to society; such as publicly-traded stock.
There is evidence for this theory. When the Federal Reserve finally raised rates to 50 basis points, money almost immediately began to drain from the equity markets, causing the steep decline we've been witnessing. It's no coincidence that the S&P 500 crested at almost the exact day rates were raised. And this gives us a great clue for determining where the bottom will occur.
There are two scenarios that could play out. In the first, low inflation remains a problem and the Fed decides to lower rates again. If this occurs absent other warning signs of a slowdown, financial markets may suck the money right back up and speed off into the next bull market. While I'll admit this scenario doesn't seem all that likely to actually occur, it's certainly possible and therefore something that should be on your radar.
In scenario two, the Fed continues to raise rates. Eventually, the money that was inappropriately pushed into the financial markets will have completely leaked out as lending becomes more and more attractive. When this happens, markets will stop falling in the days and weeks after a rate hike; the opposite of what is happening now.
At what point this happens is anyone's guess. The exceptionally low interest rates of the post-2008 financial world have distorted the commonly held beliefs about how markets, and economies for that matter, will respond to different events.
By keeping an eye out for these events, you may just catch the bottom, and that's certainly something to brag about.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.