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Everyone “knows” that the huge stimulus provided by the US government is the reason the US stock market has risen from its March 2020 lows. “When everybody thinks similarly, everybody is likely to be wrong,” Humphrey Neill, the founder of contrarian analysis, always reminded his clients.

The conventional wisdom seems to be supported by evidence. Over the last 12 months, the M2 money supply (which includes cash, checking accounts, and so-called “close money” that can be transformed into cash with ease) has risen at a faster pace than at any point in the previous six decades. The S&P 500 SPX, +1.09 percent has delivered one of its best 12-month returns ever.

This is just one piece of information. I reviewed several decades of historical data to see whether there was a statistically meaningful link between the Federal Reserve’s stimulus and the stock market, to see whether it was the exception or the rule. I came up empty-handed. Bulls should be wary of reassuring themselves that the bull market will continue simply because the The Federal Reserve has made it clear that it intends to keep pouring capital into the economy.

I used two separate measurements of the money supply to look for potential similarities. I concentrated on the M2 Money Supply (cash, checking deposits, and so-called ‘close money,’ which can be transformed into cash with ease).

and the Federal Reserve’s overall balance sheet assets (a wider indicator that represents the Fed’s direct involvement in the economy through securities and Treasury purchases). The correlations between the stock market and the money supply, regardless of description, are not constant over time.

On the one hand, there has been a clear positive correlation over the last decade, just as we’ve seen in the last 12 months and what the bulls believe is the general norm.On the other hand, prior to that, this association was negative, meaning that faster money supply growth was more often than not correlated with slower stock market growth, and vice versa. That is the exact opposite of what the bulls believe.

After this initial examination of the data, the most we can conclude is that faster money supply growth is sometimes beneficial to stocks and other times it is not.

As a result, the relationship between the money supply and the stock market appears to be much more complicated than most investors believe. While a thorough discussion of that relationship is beyond the reach of this column, we do know that it is heavily influenced by investors’ risk appetite. In a “risk-on” climate, for example, aggressive Fed easing is more likely to be considered bullish. However, if investors are focused on the downside (“risk-off”), an aggressive Fed can cause them to become even more concerned.

As is always the case, the popular British economist of a century ago, John Maynard Keynes, nailed this dynamic. He pointed out that if there is no appetite for risk-taking, central banks will be unable to boost the economy, and the Fed’s efforts will be analogous to “pushing on a loop.”

How much capital velocity varies over time is another indicator of the dynamics of the relationship between money supply and the stock market. The total amount of times money changes hands in a given year is what I’m referring to. As velocity falls, a larger money supply is needed to have the same economic effect. To put it another way, if velocity falls too far as a result of the increased money supply, it won’t be stimulating.

This brings recent events into context. As the following graph shows, velocity plummeted at the start of the pandemic and is now at one of the lowest levels in six decades.

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