Wenzel: Market Prices Reflect Information Except About Money Supply
Every now and again it’s fun to disrupt the blogospherical equilibrium by picking a fight with your allies. Hence today I will point out my serious reservations with Robert Wenzel’s analysis of stock prices and his preferred monetary aggregate, non-seasonally adjusted M2.
Back on June 12 Wenzel announced (CAPS in original):
MAJOR ALERT: Another Major Switch in Fed Policy?
After unprecedented money growth, in recent weeks I have hinted that Fed money growth was slowing. The latest data now show that money supply is now in a nosedive.The whipsaws in Fed monetary policy under Fed chairman Ben Bernanke are unprecedented.
In early 2008, money supply (M2 not seasonally-adjusted) grew at rate of around 12%. During the summer of 2008, Bernanke reversed engines and completely slammed on the breaks and slowed money supply growth to 1.2% annualized. This last money slow down is what I believe intensified the downturn.
In late September 2008, in panic, Bernanke opened the money spigot, again, For approximately 6 months we had money growth of near 15% on an annualized basis. An unprecedented amount of Fed money growth. This is what I believe is fueling the current rebound in stocks and commodities.
However, it appears that Bernanke may now be reversing policy, again. The latest numbers from the Fed show that over the last three months the money supply has actually declined. On March 9, 2009 M2 non-seasonally adjusted stood at 8363.7 billion. Yesterday, the Fed reported that as of June 1, 2009 the money supply stood at 8335.1 billion. This is an annualized decline of of 1.4% in the money supply.
Needless to say, this stock market climb is pretty much over, if Bernanke keeps this money shrinkage act up.
Just to make sure that he is still sticking to this story, yesterday Wenzel wrote:
[A]s I have warned many times, the Fed is not printing any money at the current time. Couple this with the fact that August begins the start of seasonal down trend in the market and we [could] be in for a lot of trouble.
…
If Bernanke keeps up his no money printing stance, there is a huge market break coming. Don’t be sucked in by any short term rallies. The money isn’t there to support them long term.
I have several problems with all of this. First and most serious: How can you possibly argue that stock prices respond to money supply numbers with a 3-month (or greater) lag? I understand if you want to argue that measured CPI responds only slowly to injections of new money; fair enough. But surely it shouldn’t take forward-looking investors three months to digest the implications of a change in Fed policy. Imagine if oil prices crashed one day. Would anybody say, “It was because the Saudis cut production two months ago”?
Yes, there is certainly a connection between Fed policy and nominal stock prices, but it can’t be backward-looking and with a lag (let alone a variable lag!). That is impossible to reconcile with any type of sensible expectations theory. I’m not claiming that the efficient markets hypothesis is correct; I’m just saying that it can’t possibly take speculators months to react to unexpected changes in Fed policy.
But let’s put aside all of the theoretical issues. In practice, how useful is Wenzel’s approach? Mostly because of the huge upswing today, the S&P 500 right now is up more than 3% from when Wenzel first warned us (on June 12) that the market rally was kaput. That’s more than a 20% annualized rate of appreciation, which isn’t a bad return in the present environment.
Yes yes, of COURSE the stock market is bouncing around like crazy; for all I know it might fall 3% tomorrow. And just because it rose at 3% in less than two months, it doesn’t mean it will continue to do so for the next year.
But my point is, if Wenzel’s theory is driven by 3-month changes in (nsa) M2. This variable was almost perfectly flat from the week of March 23 to the week of July 6. If the market were much lower today than it was at some point in the interval, I am quite sure Wenzel would have pointed to that as vindication of his analysis.
This is the supreme problem with monetary theories that rely on “long and variable lags.” They are non-falsifiable, because no matter what happens, you can always pore over the last two years of data and find some monetary trend to point to as “causing” whatever is happening today.
Of course, pure economic theory is a priori; Mises argued (and I agree with him–and so does Wenzel I believe) that you come to the table already armed with theories about how the economy works. It is precisely this antecedent framework that allows you to interpret the vast reams of data pouring in by the hour.
But on either count–theoretical or empirical–I don’t see how looking at lagged changes in M2 explains stock movements.
A final note: I am sure that Wenzel is much more attuned to market movements than I am. If you had $1000 to entrust to either of our calls on market timing, you would do better to give it to Wenzel. What I am saying though is that when he steps back and tries to formalize why he thinks the market will do such-and-such, he is not accurately crystallizing his tacit knowledge. But because his theory is so open-ended, I don’t think he even sees when it is being contradicted by actual events.
