Technical Thursdays: Money Growth and the Stock Market

In a prelude to next Monday’s weekly report on money growth, productivity, and equity values (rescheduled for July 30th), I want to share with you today two aspects of that report – money growth and the stock market.



A technical indicator that several astute market technicians point to is the growth of money, specifically MZM (money with zero maturity). The argument made is that money growth has provided the necessary liquidity to maintain ever-higher stock values. This is true. As long as liquidity* remains abundant, equities have an upward bias.

As the above charts show**, since 1980 the S&P 500 and MZM have trended higher at a compound annual growth rate of 10.2% and 8.5%, respectively. Obviously, stocks have fluctuated getting over and undervalued along the way. But the trend is undeniable.

Now, one might ask, is there a factor that helps explain the difference between money growth and equity value increases. The answer is none other than productivity. The compound annual growth rate of US productivity since 1980 is 1.6%. I think you can do the math: money growth at 8.5% + productivity growth at 1.6% = equity growth at 10.1%, a tenth of a percent off the actual growth rate.

Investment Strategy Implications

In next Monday’s weekly report, I will provide the details and data of these three factors – money growth, productivity, and equity values – along with the fair value levels they predict as well as a commentary on how to use the data. Until then, let me leave you with this thought – according to the data and given expectations for money growth and productivity, fair value for the S&P 500 for 2007 is 1569.67.

*Note: For the purposes of this commentary, I will limit the definition of liquidity to MZM and not include the unknowable – liquidity from non-bank lenders and leverage upon leverage in the form of instruments such as credit derivatives.

** To view a larger version of the above charts, simply click on the image