Don’t Forget about Money Supply
Greetings from Italy.
The global stock market meltdown earlier this week sent many investors into a panic. Many blame "the great unwind" of the yen carry trade. The strategy, in simple terms, involves borrowing money in a low-interest-rate environment to invest in higher-yielding assets. When the Bank of Japan raised rates last week, the yen rose sharply against the dollar, forcing those doing yen carry trades to cut their losses and sell. My guess is that there is still some time before all the unwinding is done.
On top of the chaos in Japan, there is the weak U.S. jobs report that was released around the same time.
This report triggered a recession indicator known as the Sahm Rule. U.S. unemployment rate edged higher for the fourth straight month, now standing at 4.3%— the highest since October 2021. This came just a few days after the Federal Reserve left interest rates unchanged, which many economists and analysts believe was a missed opportunity.
Nonetheless, many believe the global selloff was an overreaction.
I take a slightly more cautious approach. But that has nothing to do with the jobs report or the carry trade unwinding. What I’ve been closely monitoring is the money supply growth in the U.S.
U.S. M2 money supply peaked at US$21.722 trillion in April 2022. Since then, it has declined to US$21.025 trillion as of June 2024, representing an overall decrease of about 3.21% from the peak. This decline is historically significant because M2 had not seen such a drop in over 90 years. More importantly, during the COVID pandemic, the Fed dramatically boosted money supply by over 20% and then reduced the increase to single digits. The most recent data shows that money supply went up by 1.1% as of June 2024, compared to the same period the previous year.
The main concern is that if the M2 money supply has declined since April 2022 and hasn’t kept pace with economic growth, there could be less capital available for the discretionary spending that has driven the current economic expansion and bull market on Wall Street.
Meanwhile, I believe many investors are still in shock from this week’s stock market meltdown. Coupled with all the uncertainty currently plaguing the world —including geopolitical tensions and the upcoming U.S. election — a lot of them are running scared and rushing to pile up USD cash. With that in mind, I suspect there will be more volatility ahead in the markets.
But that doesn’t mean one should simply sit on cash and remain uninvested. I think a 20% allocation to cash in a portfolio would make sense at this point. Now is the time to save up dry powder and do your research — look for companies with little or no debt, moderate earnings growth, and high return on capital, and get ready to re-enter the market.
Tech stocks, in particular, have nosedived. I do see buying opportunities going forward because tech is still going to be a market leader. However, thus far, there has been a lot of hype in tech, leading to overvaluation. Companies with weak balance sheets, low or no earnings growth, and high debt, will be in deep trouble.