Friday, 24 February 2017

Money Supply Update (23 Feb-17)

The money supply y/y growth rate (TMSS, black line) was largely unchanged from last week. The money supply growth excluding savings deposits (TMSS-S, blue line) on the other hand fell to the lowest level recorded for more than a year.

Y/Y percentage change last 20 weeks. TMSS = the short version of the True Money Supply which excludes the last three components of the True Money Supply, TMSS-S = TMSS minus savings deposits):

2016-10-05 10,6 22,9
2016-10-12 11,3 21,6
2016-10-19 11,8 20,1
2016-10-26 11,7 20,2
2016-11-02 11,0 21,0
2016-11-09 10,2 17,4
2016-11-16 10,2 17,1
2016-11-23 10,5 15,5
2016-11-30 9,5 13,7
2016-12-07 9,2 16,3
2016-12-14 8,7 11,2
2016-12-21 8,6 8,6
2016-12-28 8,4 8,3
2017-01-04 8,3 8,6
2017-01-11 8,7 11,7
2017-01-18 9,0 11,1
2017-01-25 8,6 9,1
2017-02-01 7,6 10,2
2017-02-08 7,9 8,9
2017-02-15 7,9 7,3

My latest article published on Seeking Alpha: 

The Money Cycle, Stock Market, And The Return Of The Inflation Premium - This Chart Is Off The Scale

Wednesday, 22 February 2017

Charts of The Day: Gold, Money, Reserves, And The Stock Market

As of 17 Feb 2017

As of 17 Feb 2017

Tuesday, 21 February 2017

Stress Tests don’t work

By Gordon Kerr

Criticisms of bank stress tests continue to mount, particularly as banks continue to struggle. A new problem recently emerged: the marked shortfall between the market capitalisation of most European banks and their book values.

This should soon lead to a new stress test methodology. This will be a direct response to pressure applied to the Bank of England by Steve Baker MP and other members of the relevant Parliamentary scrutiny committee. Baker and colleagues have forced the Bank of England (the “Bank”) to respond to criticisms led by Sir John Vickers and Professor Kevin Dowd that since the current stress tests are based only on book numbers, they are unreliable.

If the Bank changes its methodology, it will surely encourage Europe to follow. Given the credibility threats facing European bank regulators, and as Unicredit’s rights issue causes further jitters in Italian bank share prices, we expect Europe to welcome such recommendations.

Continue reading the article here.

U.S. Stocks to Bank Equity Ratio - Now In The 95th Percentile

The ratio between U.S. stocks and the amount of equity for U.S. commercial banks is today in the 95th percentile based on data since 1987 and more than 21% higher than when it peaked in July 2007, just prior to the 2007-2009 bear market. 

Source: FRED® Graphs ©Federal Reserve Bank of St. Louis. 2017. All rights reserved. All FRED® Graphs appear courtesy of Federal Reserve Bank of St. Louis., Wilshire Associates

Currently, the ratio is also 39% and 44% higher than the average and median, respectively.

Furthermore, looking at the same data but on a y/y percentage change basis, the increase in the ratio during the past year is in the 97th percentile. This suggests there is a relatively low probability the ratio will move much higher during this cycle and that a reversal is perhaps the more likely scenario at this stage. 

Source: FRED® Graphs ©Federal Reserve Bank of St. Louis. 2017. All rights reserved. All FRED® Graphs appear courtesy of Federal Reserve Bank of St. Louis., Wilshire Associates

Further growth in the amount of bank equity will of course act to support stock market prices at any given ratio. But (especially at stock market peaks and troughs) stock prices can change substantially quicker than bank equity ever can. It's therefore changes in the ratio (which of course is driven by changes in stock market valuations), rather than changes in bank equity, that is the driving force of equity returns over the short- to medium term. 

Source: FRED® Graphs ©Federal Reserve Bank of St. Louis. 2017. All rights reserved. All FRED® Graphs appear courtesy of Federal Reserve Bank of St. Louis., Wilshire Associates

Over the longer term however, it's still increases in the quantity of money - which is reflected in bank balance sheets, including equity - that is the driving force of stock market prices. 

Source: FRED® Graphs ©Federal Reserve Bank of St. Louis. 2017. All rights reserved. All FRED® Graphs appear courtesy of Federal Reserve Bank of St. Louis., Wilshire Associates

For more on how the money supply affects stock market prices, including how the money cycle creates bull and bear markets, see my book Monecy Cycles - The Curse of an Elastic Money Supply now available on Amazon (Kindle version also now available):

Monday, 20 February 2017

Rising Price Inflation Expectations A Drag on Consumer Spending?

The deputy-head of investments of a large fund manager recently posted this question on Linkedin: 
The second key thing to watch for the UK this year is inflation expectations. They have been steadily rising. How much of a drag will it bring to consumer spending and what implications does it have for Monetary Policy?
Here's Sean Corrigan's reply which speaks for itself: 
How can the 'expectation' of higher prices act as a 'drag' on spending? Is the whole point not that those who think prices will rise will tend to act to buy now in anticipation of the rise, so making their expectations partly self-fulfilling? Furthermore, except when supply is curtailed, how do prices in fact rise if people are not more avidly offering their money in exchange for goods -i.e., seeking to spend more aggressively? Finally, if you are suggesting some sort of counter-intuitive short-circuit DOES indeed take place, does this ipso facto not vitiate the ludicrous idea which has so infected policy-making, that expected price falls somehow cause spending to freeze?

Saturday, 18 February 2017

On This Key Measure, US Banks Are Substantially More Fragile Today Than In 2008

As was well documented during the 2008 banking crisis, the Federal Reserve will buy nearly any securities held by banks during times of banking crisis. In this sense, it's largely irrelevant what kind of securities the banks hold. 

What's important then in assessing banks' potential liquidity is the combined value of cash (reserves) and securities the banks have relative to deposit liabilities (the money supply). Today, this ratio is substantially lower than it was on the eve of the banking crisis in September 2008. 

So, whatever you've been told about the soundness on U.S. banks, on this measure they are even more unsound today than they were back when Lehman failed. Which suggests the banking crisis could be even greater next time around. 

Two Good Reasons U.S. Stocks Are Doing Well

Reason 1: the money supply growth rate remains high. Reason 2: Interest rates remain low. Dividing the former by the latter indicates the extent of the current stimuli the two combined have on stock market prices.

As the more recent history shows, the correlation between y/y changes in the money supply divided by bond yields and stock market prices is a fairly close one. 

Not to say this is not a stock market euphoria, but there are hence indeed good reasons why stocks are doing well, for now. None of these two developments are sustainable however, which is why this bull market will end as any other bull market; with a bust.

For more on this particular topic, see: Why The Stock Market Might Move Higher In The Short Term

I explain in detail the relationships between the money supply, the business cycle, and stock market returns in my book Money Cycles - The Curse of an Elastic Money Supply.

Finance and Financial Economics: A Debate About Common Sense and Illogical Models

By Pablo Fernandez 

This document tries to answer to a frequent question of students and clients: are Finance and Financial Economics the same thing? My answer is NO: I think that they are very different, although the terms are very often confused and many Finance professor positions in many Business Schools have been filled with Financial Economists.

Two ways, among others, to see the differences: a) attend a class on “Finance for managers” taught by a sensible Finance professor and attend another taught by a “Financial Economist”; b) read a book on “Finance for managers” and another on “Financial Economics”.

Financial Economics is a subject developed by economists whose main purpose is to elaborate “models” based on unrealistic assumptions. The conclusions and predictions of the “models” have very little to do with the real world: companies, financial markets, investors, managers… the most emblematic example is the CAPM.

The most used word in the Nobel Prize lectures of Fama, Shiller, Hansen and Sharpe was “model” (513 times).

This document contains facts and some opinions held by the author. I welcome comments (disagreements, errors, anecdotes…) that will help the readers and me to better differentiate between Finance and Financial Economics.

Download the paper here.

U.S. Weekly Stock Market Valuation Indicator (as of 17 Feb 2017) - Back In 99th Percentile

This simple weekly stock market valuation indicator for the U.S. is now almost back to the 99th percentile.

As the indicator reflects stock market prices relative to the money supply and a leading economic indicator, the current reading indicates the stock market has only been valued higher on one occasion previously based on data since 1994; the period surrounding March 2000, the height of the dotcom bubble.

Note that the indicator correctly indicated the 2000 and 2007 bubbles, but that the correction following the June 2015 peak was relatively minor only short-lived. Rapid increases in bank credit was one factor acting to avert a larger correction in 2015 and 2016.

This time around however bank credit growth is contracting while loan delinquencies have been on the rise for many quarters. Betting on bank credit expansion to be the savior again might therefore currently seem like a somewhat risky bet.

Also see:

Stock Market Prices Dislocate From Bank Balance Sheets

Thursday, 16 February 2017

Money Supply Update (16 Feb-17)

The y/y growth rates for the U.S. money supply remained largely unchanged from last week and in line with the averages during the last four years or so.

The length of the current run of stable growth rates is unprecedented based on data since 1986. The slowing down in bank credit expansion shown last week could certainly soon end this run.