More Risk For Investors Is Predicted By The Decline In The Money Supply
History Teaches Us What To Expect
The old investing maxim of “don’t fight the Fed” is supported by substantial evidence that investment returns tend to be poor during times when the Federal Reserve increases interest rates and/or reduces the money supply.
The accompanying chart below demonstrates that since 1950 even a very minor dip in the M2 money supply precedes an economic recession. The only exception occurred in 2020 when the COVID pandemic prompted coordinated fiscal stimulus and dramatic growth of an already expanding money supply.
The slope of the recent decline in M2 is, by far, the steepest since 1950 which suggests that we can probably expect a sharp recession in 2023. The effects of very aggressive changes to economic policy, such as the recent aggressive increase in interest rates and decrease in money supply, typically take some time to work through the financial system which suggests the full effects of the economic slowdown designed to dampen inflationary pressures will not become apparent until 2023.
Stock markets are, at worst, pricing in that unicorn of economic recessions the “soft-landing.” If the developing recession is of average severity or the sharper version we anticipate, then further market volatility such as has been seen in 2022 can be expected.
We continue to believe the requirements to end the current bear market will be the end of Fed interest rate increases, renewed expansion of the money supply, and ideally an extreme of negative investor sentiment that produces a bout of capitulation selling.
We continue to expect the 2020s will be characterized by unusually high market volatility which will produce significant risks but also great opportunities for informed investors.
Each month in the Global Investment Letter I update my investing activities, as well as comment on major global equity, fixed income, currency, and commodity markets.
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