Wednesday, July 15, 2009

The S&P 500 and the Money Supply: A Long Term Look

Andy Kessler wrote a rather frank op-ed in today's Wall Street Journal, at one point devoting an entire sentence to the phrase "dumb move" as he issued a critique of Fed/Treasury/Government behavior since the onset of the "Crisis". Mr. Kessler asserts, rightly so we believe, that the recent stock market rally is the result of the Federal Reserve's $1Trillion increase to the monetary base. To illustrate his point, Mr. Kessler includes an intriguing chart, which plots the WSBASE (via St. Louis Fed) and the Dow Jones Industrial Average for the period of January-July 2009. For the most part, the WSBASE represents the sum of currency in circulation, plus reserve balances held by Federal Reserve Banks. The theory goes that even though the majority of Fed activity has focused on the purchase of Treasuries and Mortgage Backed Securities, the stock market has served as the primary recipient of the newly created portion of the monetary base. We would tend to agree.

So enamored were we by Mr. Kessler's 6-month WSBASE v Dow chart that we couldn't help create a similar chart; ours however includes the entire available time series of WSBASE data, beginning in 1984. We chose to use the S&P 500 as the comparison index, simply because the Dow is a rather poorly constructed index that doesn't lend itself to long term comparisons. For accuracy and presentation's sake we went with the logarithmic scale.

It's interesting to note that the the WSBASE and the S&P 500 do appear to trend together, diverging slightly during times of over-valued equity markets (the late 90's). However, if one hone's in on the disruptive period of stock market action following the Lehman collapse - referred to in jest in our circles as "The Death March" - it is clear that the Fed pulled violently on it's monetary levers in an attempt to bolster the equity market. This backstop may be effective for some period of time, however, the Market will ultimately prevail. Caveat Emptor.
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