Money Supply Watch, the Stock Market, and How To Know When The Fear Has Bottomed

In the old days, during the Volcker Era at the Fed, the stock market used to live and breathe with the money supply numbers. Now, I can probably count on one hand the number of money supply watchers out there, including myself.

That said, the money supply numbers are still the key numbers to watch for clues about the economy and stock market. Without new money being pumped into the system, the stock market isn't going anywhere for awhile. And, don't think that Bernanke has been pumping money to save the mortgage industry over the last year. Bernanke has been dramatically slowing money supply, as I warned, leading up to the current crisis in stock market, here, here, here, here, here,here, here and here.

Given the decimation in the stock market, the Bernanke Fed is likely to start pumping again. Indeed, we are starting to see the first signs of this in the numbers released over the last two weeks. Last week, we saw M2 jump by roughly 100 billion dollars. This weeks numbers, which are for the period ending September 29, show three month annualized M2 growth at 3.5% (This is based on the 13-week average numbers) . This is by no means dramatic growth, but given that just weeks ago (Sept 8)three month annualized M2 growth was at only 1.5%, this is a significant turnaround in the direction of money growth toward to the upside.

M2 money numbers over the next two to three weeks should give us a good clue as to how aggressively the Fed is pumping money, in light of the current crisis environment.

It should also be noted that M1 is soaring. Although, this is not a good measure of of overall money in the system, because it is too narrow and only includes such items as physical currency and demand deposits, i.e., checking deposits. It is a good measure of fear in the system, since the money now flowing into demand deposits is money that was in money market funds and bond funds. 12 month annualized M1 growth was only at 1.8%. The recent Fed release shows 3 month annualized M1 growth at an amazing (given the Fed hasn't been pumping money into the system) growth of 11.7%--based on the thirteen week average data assembled by the Fed.

Thus, M1 is truly measuring the fear in the system. Watch for a slowdown in M1 growth to indicate that fear is subsiding.

So here is the key to watching for a clue as to a bottom in the stock market: Continued strong increases in the 3 month annualized M2 to growth rates, coupled with a significant slowdown in M1. At a minimum, M1 growth shouldn't be any greater than M2 growth. With the Fed pumping money, signalled by M2 growth, and fear subsiding, signalled by a slowdown in M1, you have a recipe for an up stock market.