Money Supply is Shrinking

And no one cares.  Market forecasters and economists are great at extrapolating the past into the future.  They are great at taking short term trends and make them seem like long term trends.  The church of what's happening now is always the busiest, and has the most members.  People could care less about what happens 2-3 years from now, they want to know what will happen today, this week, this month, etc. 

The money supply is doing something that is very uncommon, and its not getting much attention.  Its going down, and very rapidly in the past month.  The U turn that governments and central banks have taken in 2022 in both fiscal and monetary policy is having a big impact in the very foundation of the money game.  The supply of money.  M1 money supply is barely up year over year in the US, and has been falling since January.  

U.S. M1 Money Supply

Look at that big drop in September, that's not conducive to continual high inflation.  Yet, many are extrapolating the sticky core inflation into 2023, forgetting that levels don't matter.  Remember, inflation is a rate of change statistic, if you go from 10 to 100 and go down to 90, that's considered deflation.  The same thing happened with the money supply.  You had a huge burst higher in the money supply in 2020 and 2021, and that's completely stopped and even gone a bit into reverse in 2022.  2023 will surprise people in how fast the inflation rate goes down because of year over year base effects and shrinking supply of narrow money, one of the best predictors of future economic growth and inflation, of course with about a 12-15 month lag.  

I know people love to talk about supply chains, Russia Ukraine war, food and energy prices, wage growth, etc.  It makes for a nice story, but they don't control inflation.  Inflation is controlled by the supply of money and the amount of goods and services available.  The rate of change of the supply of money is usually much more dynamic and variable than the rate of change in the total amount of goods and services.  Thus, money supply is ultimately the main factor in deciding the rate of inflation.  The reason Japan has had much lower rates of inflation than the rest of the world is because its had the lowest rate of money supply growth by a mile.  

Japan's M2 money supply has gone up ~ 100% over the past 25 years, while the US M2 money supply has gone up over 350% over that time period.  That is why the US has had a higher rate of inflation than Japan, not demographics or any other "smart" explanations economists and market "experts" come up with.  Just look up the M2 money supply in Argentina and you will see where the inflation is coming from there.

Milton Friedman was right, inflation is a monetary phenomena.  A wage-price spiral has the order incorrect.  Its a money supply - price - wage spiral.  An increase in the supply of money fuels higher prices which results in workers demanding and receiving higher wages.   

The CPI data comes out Thursday, and it is the big market mover these days, like what the NFP used to be back in the day.  I have no idea what the CPI will do in the near term, but investors are overestimating the stickiness of core CPI, as leading indicators, including the M1 money supply, are forecasting a sharp deceleration in 2023.  

No one really cares about money supply these days because it works with such a huge lag, and its like the iceberg that's slowly moving, yet people think its sitting still.  Given time, huge effects are seen from the increase or decrease in the money supply.  But we are living in a world of instant information, instant gratification, just a torrent of information overload that gets most people focused on the news/economic data for the day.  Its encourages excessive trading and very short time frames. 

Counterintuitively, the reduction of commissions to near zero and the ease with which trades are placed is the most value destructive evolution in retail investing.  This evolution has helped line the pockets of the payment for order flow market makers like Citadel, Susquehanna, Wolverine, etc. as well as the front running HFTs which are the bane of the existence for active fund managers.  

Profitable daytrading can be done, but its trying to make money the hard way when there are so many other ways to do it that are higher probability, have less slippage, and less prone to execution error.  I guess some people are just so averse to taking overnight risk or can't sleep at night if they have a position on that they stick with daytrading.  With the amount of 0DTE options being traded these days, the intraday patterns have changed, and I'm sure there are some tradable patterns, but its not really my style looking for quick move.  I would rather lean on levels and price exhaustion to find opportunities.  

We are getting a grind higher into the midterm elections.  I am sensing a growing level of optimism about the market despite the tech wreck that I see almost everyday in the market.  Its irrational, but investors have been mesmerized by stocks over the years, and BTFD and TINA mindset are still there among the community.  But tech stocks are the leaders.  No matter how well other sectors are trading, tech is still the guiding light for this market, and without tech leadership and strength, it will be difficult for the market to keep going higher.  And looking at how earnings are turning for the worse among the tech names, and how crowded they still are among retail, I expect a replay of what you saw in the dotcom bubble where tech stocks underperformed in a bear market for 2 years.  We just completed year 1 of the underperformance.  I think there is at least another year left.  

We are still seeing fairly steady inflows into equity funds despite the poor performance this year.  Let's not forget that from 2010 to 2020, there was almost always a constant inflow into bonds and out of equity funds except for very brief periods in 2013 and 2018.  It has been the opposite in 2022.  Gut feel that investors are doing the wrong thing again this time around, selling bonds and buying stocks.

Been laying low for the past few days, not seeing a high probability trade.  With the midterm elections and CPI this week, it would not surprise me to see stocks and bonds both higher on a relief rally after the events have passed.  That could set up a top for opex next week when you have the big monthly Friday expiration.  SPX 3900-3950 would be a good spot to short.