There Is A Long Way To Go Before This Bull Overheats And Dies

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Includes: DDM, DIA, DOG, DXD, EEH, EPS, EQL, FEX, FWDD, HUSV, IVV, IWL, IWM, JHML, JKD, OTPIX, PSQ, QID, QLD, QQEW, QQQ, QQQE, QQXT, RSP, RWM, RYARX, RYRSX, SCHX, SDOW, SDS, SFLA, SH, SMLL, SPDN, SPLX, SPUU, SPXE, SPXL, SPXN, SPXS, SPXT, SPXU, SPXV, SPY, SQQQ, SRTY, SSO, SYE, TNA, TQQQ, TWM, TZA, UDOW, UDPIX, UPRO, URTY, UWM, VFINX, VOO, VTWO, VV
by: ANG Traders

Summary

The velocity of money tends to increase in the second half of expansions.

In the current expansion, the velocity has only just begun to increase.

When it comes to GDP growth rates, the current expansion has more in common with the 1982-2000 bull market than 2003-2007.

There is too much fear present in the market for the end to be near.

It looks like we are in the midst of the third major stock market rally of the last 100 years.

The fact that this bull market has been alive for ten years is not reason enough to declare it is nearing the end. In fact, there is an argument to be made that, since the real economy is only now receiving some of those QE funds and starting to grow, there is still substantial room for growth before it is in danger of overheating.

GDP:M2 (Velocity Of Money)

The stock market has been rising for a decade now, fueled by fear/incredulity and monetary (M2) expansion. The GDP:M2 ratio, referred to as the velocity of money, represents how often each dollar of M2 money stock is used to purchase domestically-produced goods and services within a given time period. Between 1959 and 1990, it averaged 1.75; between 1995 and 1999, it was 2.20; and today, it is at a historic low of 1.46.

The velocity of money tends to increase during the latter half of expansions as the economy starts to heat up. Five of the last six expansions behaved this way (chart below). However, if we disregard the brief and shallow contraction of 1991, and view 1982 to 2000 as one long expansion, then all of the last five expansions displayed an increase in the velocity of money in their second halves.

Focusing in on the last four decades of the stock market (chart below), we notice that the velocity of money increased during both the long 1982-2000 bull market, and the shorter 2003-2007 housing rally. Until recently, the present bull market has been accompanied be steadily decreasing velocity of money. Only since the beginning of this year, has the velocity of money started to accelerate, which implies that we are only now entering the second half of the current expansion.

The Quantitative Easing that started in 2009, expanded the M2 monetary base, but those new funds were, for the most part, delivered to and retained by the financial industry, not the broader economy. As a consequence, stocks and bonds benefited disproportionately, compared to the GDP. We saw inflation in these assets while the velocity of money and the rest of the economy struggled to stay afloat.

We suspect that the recent increase in wages is responsible for the newly-increasing velocity. Wages allow the monetary base to enter the real economy and increase business transactions. Every dollar that enters the base of the economic pyramid gets used repeatedly to buy goods and services which increases velocity and business activity (chart below).

GDP Growth

When it comes to GDP growth rates, today's situation is more similar to the period 1982-2000 than it is to 2003-2007. During both the 80s and the first half dozen years of the current expansion, the rate of change of GDP declined while the stock market increased (red arrows in chart below). During the 90s, and currently since 2016, both the rate of change in GDP and the stock market increased together (green arrows in chart below). The market in 2003-2007 did not follow this path.

If we now pull out and look at the last 100 years, we see a staircase pattern that further supports the idea that today's bull market has more in common with 1982-2000 than with 2003-2007. It is becoming increasingly likely that we are in the midst of the third major up-leg of the century (chart below).

Fear

The fact that you could almost taste the fear in the market during the pullback of the final two days of last week, despite the market being only within 1.5% of an all-time high, confirms that the market will continue to climb the proverbial 'wall of worry'.

There will be corrections, even painful ones, along the way, but bull markets do not end by drowning in fear. Bull markets die from overheating in a vat of euphoria. This bull market has a long way to go before it gets overheated and dies.

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.