This One Trend is Driving Every Financial Market

Regardless of which market we look at, we see a similar trend: skyrocketing prices since the beginning of the pandemic. You can see this in the S&P 500, a broad measure of stocks:

In commodities:

In the increase in real estate prices and the corresponding decrease in capitalization rates (this chart is from Dallas…see similar trends in other cities in the research papers linked in this post):

And even in Treasury bonds (recall that the yield moves in the opposite direction from the price, so a lower yield means a higher price):

Why are all these markets looking the same? The likeliest cause is a huge jump in the money supply. The Federal Reserve has aggressively printed money since the beginning of the pandemic, looking to counter the seismic economic shock. I think this is probably appropriate. In any case, the effect is unmistakable, however you measure money supply.

Here’s how the “monetary base,” or “the sum of currency in circulation and reserve balances (deposits held by banks and other depository institutions in their accounts at the Federal Reserve),” has expanded:

If you look at another definition of the money supply, M1 (“the sum of currency held by the public and transaction deposits at depository institutions”), it looks like this:

And if you broaden your definition of money supply to M2 (“M1 plus savings deposits, small-denomination time deposits (those issued in amounts of less than $100,000), and retail money market mutual fund shares”), you see the same familiar pattern:

Whichever way you slice it, there’s a lot more money out there than there used to be. That money can be used to bid up stocks, bonds, real estate, commodities, bitcoin, Gamestop, or whatever you like.

There is some debate in the literature about whether you can draw a correlation between the money supply and increasing stock prices. This study sounds a cautionary note:

future profits may not change, if interest rates decline at the same time that demand for firms’ products, and thus their sales, decline.

This could be relevant for companies that can’t deliver their products in a contactless manner. But companies that can have been thriving.

In all, it appears that the massive increase in the money supply is driving financial markets of every stripe in one direction: up. Until the Fed changes policy, I suspect the bias is likely to be toward buoyant markets, especially with vaccines coming on line and the pandemic’s end in sight.

Have a great weekend, everyone!

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Photo: “Governor Jerome Powell speaks at Brookings panel, ‘Are there structural issues in U.S. bond markets?’” by BrookingsInst is licensed under CC BY-NC-ND 2.0