eQuity markets are counting on central Bank easing for support

Markets appear to be betting that loose liquidity will dominate weaker fundamentals. Syed Mansoor Mohi-uddin, global macro strategist at UBS, noted changes in U.S. dollar liquidity and performance of the S&P 500 have flipped since the credit crunch began in 2007. “Before the crisis, money supply growth and equity market returns were positively correlated,” he said, pointing to standard economic theory that stronger growth translates into higher demand for credit, increased supply of loans and higher stock values if companies invest borrowed funds profitably over time. But since 2007-08, Mr. Mohi-uddin noted the relationship has become negatively correlated. He told clients “plunges in stock markets have been matched by sharp increases in liquidity while stronger equity performance has become associated with periods of low growth in overall dollar money supply.” Since the S&P 500 has made doubledigit gains so far in 2013, even though overall dollar liquidity is barely growing on a three-month moving average basis, he said the flip shows “equity markets are counting on further central bank easing if stock prices start to decline.” Mr. Mohi-uddin thinks this may explain the resilience of investor sentiment in the face of disappointing data ahead of the Federal Reserve and European Central Bank meetings this week. The Fed stopped publishing data on broad money supply (M3) before the financial crisis began in 2007, but puts out weekly data on M2 money supply. The New York Fed also publishes weekly data on custody holdings of treasury and agency debt by official foreign institutions, which serves as a good proxy for central banks’ global reserve holdings of dollars. Adding the two measures together gives an estimate of the changes in global dollar liquidity. This measure of the total U.S. money supply has expanded in a year-over-year range of 2.5% to 12.5% over the past decade and a zero-to-5% range over a three-month period.