Stock markets love (earnings) growth. But what they love even more is money - the more the better. An abundant supply of money has several advantages for stock markets. A large supply of money goes hand in hand with falling interest rates, which makes stocks more attractive compared to interest-bearing investments. Even if profits remain unchanged, share prices can still rise. However, a large supply of money also leads to an increasing demand for investment if the increasing money supply is not absorbed by the demand for goods and services. Last year, the M2 money supply in the US alone increased by nearly 25 percent.
The average growth in money supply has been 7.1 percent per annum over the past 20 years. The figures for the Euro are not quite as dramatic when compared to the US dollar, but are heading in the same direction with around 12 percent growth in 2020 and an average of just under 6 percent per annum. Most of the growth in money supply has benefited the capital markets, i.e. stocks, bonds and real estate. Even the slump in growth last year caused by the Coronavirus pandemic only slightly impacted the stock markets: At the end of 2020, the MSCI ACWI index was up 6.7 percent in Euro.
Hopes of a growth spurt at the end of the Coronavirus pandemic, coupled with money surplus, has already resulted in the index rising by around 16 percent by mid-2021. This is well above the ten-year average of around 12 percent per annum.
Even if one continues to adhere to the thesis that equities offer no alternatives, one should not lose sight of the fact that monetary policy will slowly but surely normalize. This means that money supply will settle around long-term average growth of around 7 percent per annum. In the US, money supply growth has already fallen from 27.1 percent at the end of February to 13.8 percent at the end of May 2021. It is only a matter of time before money supply growth loses its stimulating effect on the stock market. Even if central banks cannot squeeze the toothpaste, i.e. the money supply, back into the tube, they will significantly slow down the squeezing out of the tube.
Despite rising inflation rates, central banks will shy away from raising the price of money, i.e. interest rates. This would have a negative impact on economic growth and the expansionary fiscal policy that is still needed. Reducing bond purchases is therefore the Central banks' first choice of preferred measures to stabilize confidence in monetary policy. The US Federal Reserve has already started to think about this but will probably only discuss such an option at the end of August or the beginning of September. The air is getting thinner in the stock markets, making individual stock selection more important.
