Markets recently got a reprieve, with the end of the bear market looking like it was already here. Then the BLS announced a shocking new 40-year high for inflation (8.6%, 0.3 percentage points above expectations), driven again by fuel, food, and housing—in other words, the essentials. This freaked markets out, which fell on Friday and started this week in negative territory, flirting with new 52-week lows.
That’s not too surprising—the S&P 500 (SPY) has been struggling for a long time—but what’s interesting is that everything else is down. Long-term Treasuries are in a bear market as of last week, bitcoin is down 50% from the start of the year (other cryptocurrencies are faring much worse), and even home prices—the one area where investors have been doing very nicely—are starting to see growing values taper as pending home sales fall.
At first glance, it may sound impossible—how can everything fall in value at the same time? The money must go somewhere, right? And that is true—but the explanation of how everything can fall simultaneously is a bit more complicated, and demands a focus on capital flows.
Simply put, capital flows is like a river of money, and as trends in markets change the flow of the river changes course. As money flows away from stocks, bonds, and real estate, it flows to other areas, giving those new areas value instead. One place has been in the value of the U.S. dollar itself—a currency that has seen its value go up nearly 8% in 2022, and an unusually massive 14.4% over the past year.
A more expensive dollar isn’t the only explanation, however. Another important consideration that Wall Street traders focus on often is margin levels. Fortunately, this data is freely available from FINRA, and a quick glance shows that margin balances have fallen by over $50 billion in 2022—which means a lot of buying through borrowing has ceased, driving less demand for assets and thus a lower price.
A third and more controversial potential explanation is the money supply. According to the Federal Reserve, there is about $20.6 trillion in U.S. money sloshing around the world economy in various accounts—up from $16.3 trillion in May 2020 (money supply was calculated differently before this, so comparing numbers before that time to after is apples to oranges and should be avoided). But the money supply started falling in April—which some take to be evidence that there’s less money in the economy to buy assets.
Of course, the bear market started before then and stock values and money supply have never been correlated over the short term—which is why a money supply explanation is controversial (and for many on Wall Street, a discredited conspiracy theory). A much more nuanced analysis of monetary dynamics would also require a study of money velocity, the cost of money, and regulatory demands for money and assets with a high degree of moneyness. These are complicated (and possibly unanswerable) macroeconomic questions, which is why they aren’t as often analyzed as margin debt and dollar value are.
Nonetheless, looking at the stock and flow of money from a variety of angles and how they influence investor activity and demand is key for traders looking to understand what market dynamics are and how they might change on a dime. So far, we’ve had a few moments where the bear market seemed over; and so far, those all turned out to be head fakes. A better understanding of money dynamics could get traders a clearer signal—and some strongly believe their formulas for analyzing these dynamics do just that.
