Why Stocks May Still Have a Long Way to Fall

The scary market action over the past week may not be over yet, nor for a while. In fact, the Dow’s 567-point bounce on the traditional “Turnaround Tuesday,” may turn out to be only a very brief respite in the beginning of a months-long decline in equities that could last through the summer.

The main problem is that liquidity in the banking system is drying up at a time when the quarterly increase in money supply is typically at its strongest. The Federal Reserve’s current Money Stock Measures report, which measures M2 money stock on a weekly basis, shows M2 growing at only 3.3% on a seasonally adjusted quarterly basis. See the small table immediately below table 2 at the link above.

That number itself is not so dangerous, since it has happened before without much consequence, particularly in 2010 when seasonal M2 quarterly expansion rates were even lower at this time of year. However, keep in mind that stock prices in 2010 were still much lower than they were in 2007 when the absolute M2 measure was 17% lower than it was three years later in 2010. That means the ratio of available liquidity to equity levels was still much higher in 2010 than it was in 2007 despite the very low growth rates at the time. Still, from January through September 2010, the Dow Jones was nevertheless stuck in a trading range and didn’t break out until October.

This time, stocks are — or rather just were — at all-time highs, so this is the first time since the Fed has records available on its website that M2 growth rates are this low, at this time of year, with stocks still in the nosebleed section.

[nativounit]

But there are more worrisome pieces to this puzzle. The seven weeks from the second week of January until the first week of March has consistently shown a shrinking M2 figure for every year since 2009. From that year until 2017, the one-week snapshot M2 average during these seven weeks has fallen anywhere from 0.23% in 2015 to as much as 1.5% in 2013 compared to the second week of January. If that repeats again this year, the already anemic liquidity growth could shrink even further into March.

That would put us six weeks away from the annual Tax Day collapse in liquidity that happens every year without fail and usually runs into at least August and sometimes even through September. This is arguably why August, September and October are typically very dangerous months for equities.

It’s difficult to tell just yet, and if markets continue their free fall in the short term the Fed could still announce a resumption of quantitative easing that would reverse these monetary trends very quickly and save stocks. But if these monetary trends continue and the Fed sticks to its rate hike plans, the fall from here could be prolonged and deep. What we have seen over the past few trading days could be just the beginning.

[recirclink id=441822]

[wallst_email_signup]