Why The Stock Market Might Move Higher In The Short Term

| About: SPDR S&P (SPY)


Elevated monetary inflation has supported high stock market valuations in recent years.

Though this bull market is only sustainable to the extent monetary inflation can remain high, current levels of stock market prices relative to the money supply suggest further upside potential.

Therefore, the bull market might not yet be on its last leg as long as monetary inflation remains high and interest rates continue to be low.

A few key factors have allowed the stock market to remain pricey for the last few years. Firstly, the level of interest rates have remained low. Secondly, money supply growth, partly the reason for the former, has remained high in the aftermath of the 2008 banking crisis. Thirdly, and perhaps most importantly, investments in the U.S. have been low during the past decade. An important consequence of this is that there has been no traditional economic boom during the last eight years. As I recently explained, this likely have had a calming effect on the business cycle which has made it possible for an extended period of low interest rates and high monetary inflation.

Now, this bull market has to eventually come to an end because ever-inflating stock market prices are largely a monetary phenomenon (I explain in detail why here). Essentially, the stock market cycle is in many ways a reflection of the money cycle, i.e. trends in changes in the money supply growth rate. Hence, as the pace of monetary expansion comes to an end, so will ever-rising stock market prices (here).

Nonetheless, the bull market might not yet be on its last leg as long as monetary inflation remains high and interest rates continue to be low. The combination is rocket fuel for stock prices, and current levels suggest there is further room for the stock market to move higher, at least over the short term. In the chart below, the black line is the year on year (y/y) percentage change in the money supply divided by corporate bond yield - the higher the line moves the more positive for stocks. The red line represents the y/y percentage change in the Russell 3000, a broad U.S. stock market index.

Also, stock market prices relative to the money supply is high compared to levels prior to mid 1990s, but still short of the peaks from early 2000s and 2007. This also indicate stocks have room to move higher.

Having said that, stock prices compared to the money supply are justifiably lower today since the ratio of overall corporate profits to the money supply is relatively low in a historical perspective...

...leaving the ratio of stock market capitalizations to corporate profits high in a historical perspective.

Despite lofty valuations, the still high money supply growth rate and low interest rates present many yield-seeking investors few other options than to put their money in the stock market. As long as this remains true, the stock market may move higher still.

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.

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