Fiat Money Explosion. Levitation and Instability.
The US money supply explosion in 2020 was far beyond anything we have experienced before, and yet it was also just a continuation of the pattern of sustained acceleration in the growth of M1 US money supply for the last 4 decades.
Speculators ascribe all manner of narratives to the extraordinary asset rallies of 2020 but the global liquidity surge from the major central banks is, in my opinion, the main driver. The chart below shows that it is hard to ignore the correlation between global liquidity and the price gains in the S&P 500 index.
The US debt expansion has matched the monetary explosion.
The greatest questions for markets going forward is how long can this policy response appear to carry no negative consequences for asset prices or the economy in the long term. In previous notes it has been shown that the ex-debt underlying US economy has remained chronically weak since 2007, despite all the record and ever growing policy “support”.
It appears that it is the market that is being supported not the overall economy, beyond the very short term..
Increasingly, aggregate economic growth has become dependent on ever larger money supply growth and deficit spending, often described as Modern Monetary Theory, or MMT for short. No doubt this will continue in the near term as it has become the modus operandi of policy.
Market behaviour is now in an altered state as MMT, or debt and money injections, has continued to accelerate to ever greater extremes. Market valuations have escaped to new historical extremes across assets classes, most notably stocks and bonds.
For bonds this is best illustrated by the 5 year Treasury Inflation Protected Securities in the US the recent auction reached a new all time low NEGATIVE real yield of 1.575%.
For equities the gap between GAAP earnings and the S&P 500 has never been wider.
As discussed a year ago investors are already in a long term prospective return crisis, the greater the distortion the greater the long term investment challenge is going to be.
Even in the short term the instability of inflation and growth cycles is also growing as increasingly this reflects extreme money and debt injections, rather than natural economic developments.
Twice in 2020 the highest probability economic environment switched from declining growth and inflation (quad 4) to rising growth and inflation (quad 2) just within a month. Typically these cycles last much longer. This is therefore a very challenging environment for any investors that are not highly adaptive.
Long term returns look very challenging and short term returns require successful and timely navigation.
For now the short term tailwinds look strong into early 2021 with the whole world entering a likely rising growth and inflation phase (quad 2) into Q2 2021.
Nevertheless, investors constantly need to wear two hats at all times. Massive policy injections create positive short term market conditions, even as long term risks and instability continues to rise.
Investors need a robust process that can handle these extreme and rapidly changing conditions effectively.
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