Monthly Market Report - September 2018

September 2018

1st September 2018

My main worry at the moment is that investors are guilty of an element of cognitive dissonance when it comes to QE and its new, potentially ugly sibling quantitative tightening (QT). The consensus was that QE was a potent tailwind for equity valuations. QT by comparison is shrugged off as ‘normalisation’. The always-excellent James Ferguson over at Macro Strategy has recently suggested that this consensus is just plain wrong and that QT will probably result in monetary contraction and declining asset prices. Or as James puts it "QE was inflationary and so efficacious in preventing money supply contraction, thereby pushing up risk assets and long bond yields…it would be irrational not to expect QE do the exact opposite”.

Ferguson calculates that each $100 bn of QE asset purchases "on the face of it boosted equity valuations by +5.7%. We are looking at as much as $320 bn of anti QE through the remainder of this year”. On that basis, a correction of 15% is in order i.e. a massive taper tantrum spasm. Investors looking for evidence of a possible bearish turn in sentiment should monitor money supply and bank credit creation. In the absence of QE, bank deposits shrink, loan creation ebbs away and we end up with deflation, defined as a nominal contraction in broad money supply. That makes Treasuries the only sensible investment. By contrast, with QE investors dump safety, chase yield and buy risky assets. So, what’s happening with current money supply numbers? Ferguson reports that US M2 money supply is now only growing at 4% per annum, while the broader M2 measure is slightly higher at 4.4% and bank loan creation at 4.2%. These are all well down from recent levels of between 5 to 8% for each measure.

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