M2 And The Bubble Zone - When It's Better To Be In Cash

For a while, I've been looking at SPX versus M2 money supply. This is essentially a way of looking at the relationship between cash and assets. I've also been watching the U.S. Dollar index ( DXY ), and how it's reached a standstill - neither in a downtrend nor an uptrend. What happens next seems impossible to predict, but I think it's important to watch the SPX / M2 ratio. Historically, it appears that it's better to start accumulating cash once the ratio reaches this current level - a ratio higher than this has ONLY been seen during the dotcom boom in the late 90's. In this analysis, I make an effort to explain these complex relationships. In the end, I may have more questions than answers, but this is what keeps me going. I'm just along for the ride.

Here are some observations:

1) The demand for cash tends to go up once the market has reached its peak (look at how DXY continued to climb after the dotcom bubble pop). DXY also went up as the stock market crashed in 2008-2009 during the financial crisis. The demand for cash also increased momentarily during the COVID market crash in March, 2020. These events are marked in purple on my chart.

2) DXY does not always go up while stocks go down, or vice versa. Instead, when they trend up together it can indicate that the market is getting closer to a peak. The dollar was quite strong during the final phase of the dotcom boom. Money printing basically stopped between 1990 and 1995 (look at the M2 chart by itself). It also stopped briefly after the stimulus in 2009. The money supply does not decline, but it can slow down.
DXY often goes down the most aggressively when markets have ALREADY BOTTOMED OUT. An exception would be 2008, where DXY dropped like a big heavy stone before the market crashed. This is probably because the financial crisis was fallout from a debt bubble in the housing market, where the demand for cash was low.

3) The largest market expansion where stocks outpaced M2 money supply occurred between 1985 and 2000, showing that Reagan's Neoliberal economic policies worked (at least for those who already held stocks, and corporations). Yet, as we know, inequality has increased drastically during that time and wages have stagnated in the U.S. These policies mostly benefitted the wealthiest people across the globe, and the U.S. has slowly (and now quickly) become more politically and socially divided. During that 15-year period, the value of cash plummeted from its peak, and the demand for dollars remained somewhat low. The money went into innovation and wealth generation.

4) Generally speaking, regulators seem to not like seeing growth outpace money supply much beyond this level. 0.22 is historical resistance. So the talk of "Tapering" and lowering interest rates makes sense here. The next section is about why things are getting interesting.

But, there's an elephant in the room.

The stock market peaked at precisely this level against M2 in 2007. At that time, SPX was only about 1/3rd of its current value. This is because money supply has increased by the same amount. This money supply has allowed for the liquidity necessary to propel the stock market to current values. Printing money should (in theory) devalue said money. But that's not what's happening. Instead, dollars remain neutral. Additionally, the demand for debt seems high, with interest rates at historic lows. So could the demand for dollars be coming from elsewhere? It could be because many economies are unfortunately tied to the dollar, and are in massive amounts of debt. As hyper-inflation hits many nations around the world, the demand for dollars on their end increases. In this case, are cryptocurrencies a remedy? El Salvador seems to think so, but we don't know yet how things will evolve.

If I were an economist, I'd probably have a lot more insight about this. Or maybe I wouldn't. Maybe economics is truly just a bunch of guesswork. There are a lot of moving parts here, and it's quite complex. So much so that it feels like a puzzle. Perhaps there is no "figuring it out," but clearly I enjoy thinking about these things.


Based on the above observations, it seems that we are in a period of uncertainty about the U.S. Dollar. It doesn't seem like the low demand for cash has hit the market yet. We will need to see DXY head below 89 to at least confirm that dollars are still in some sort of downtrend. If cryptocurrencies can achieve Gold's market cap in the near future ($11 Trillion), we could see Bitcoin and Ethereum become reserve assets themselves, so their relationship to DXY may become influenced by other variables. The general uncertainty and unease are understandable in a world characterized by a pandemic, ideological radicalization, and climate disaster. Not being able to pinpoint a narrative for humanity is reflected in the markets, with how irrational things have seemingly become.

What we can see is that SPX could be finally about to break out against M2 money supply. Even though SPX has gone 3x since its 2007 peak, the amount of cash also increased by the same amount. Is this true growth? I think investing in infrastructure, green technology, and other important things can fuel some real expansion. I would LIKE to see SPX break away from M2 here. This growth could result in bubble-like behavior in the stock market. But this kind of emotional excitement is helpful in getting industries started, as a large amount of capital flows into them. I would like to see this with green technology and more sustainable innovation. If SPX breaks out, that's when accumulating some more cash may not be a bad idea. Even accumulating cash at this resistance level could be a smart move, considering what happened in 2008.

Are we headed towards a train wreck? Or are we already in the train wreck and trying to work our way out of the rubble? The universe has an interesting way of transferring energy. As chaotic energy ebbs and flows within markets, other dynamics change. Let's see what happens.

This is of course highly speculative. I am not an economist nor a certified financial advisor. This should not be taken as a recommendation to buy or sell.

-Victor Cobra
Comment: This analysis also shows that it might be better to accumulate non-cash assets if the SPX/M2 ratio declines back to 0.08. That may take some time and patience.

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