Ever since the David Tepper interview last week on CNBC we have heard a lot about how money supply is finally expanding.  Yes, M2 has been rising the last several weeks, but before the hyper inflation crowd gets out of control we thought it would be a good idea to look at the actual numbers.

Looking at a plain chart of M2 you can see that yes it has broken to new highs but it really only declined for about six weeks back in March and April of 2010.  During this time and since then we have seen bond yields drop lower and lower indicating that inflation is essentially non-existent.  So this rising M2 is really nothing new.

M2

To get a better picture of the money supply we can look at M3 data.  In the chart below we have M3 with the 12-month ROC overlaid.  As you can see not only has M3 been headed slowly but continually lower but the 12-month ROC has not exactly rocketed higher.  Yes, it has improved but marginally at best.

M3 and M3 Annual ROC

Finally lets look at a chart that we showed a few months back when we discussed money supply being quite tight.  If we look at real M3 adjusted for inflation minus industrial production we get a good view of how loose or tight money supply is relative to growth in the economy.  As you can see in the chart below things have improved a bit but they are still extremely low from a historical perspective.

Real Money Supply (M3) minus Industrial Production (Year-to-Year Changes)

So while M2 has been improving a bit and overall money supply is a bit improved we are not exactly awash in liquidity.  No, despite the best if a bit misguided efforts by the Fed to flood the planet with US Dollars, the massive deleveraging has managed to cancel most of it out.  So before you run out and short the hell out of the bond market, load the boat with stocks, and go all in on commodities stop and think about the likely scenario.  Do you really think that hyper inflation is right around the corner?  We obviously don’t.  We continue to be of the thought that the Fed will do what it thinks it should and while it will help financial assets go higher it will not really go into the real economy and consequently we will see little real inflation for the next year or two or maybe even longer.  Yes, we are long stocks but we are not long in size and we continue to trade commodities cautiously.  So while the Fed put might be, the  minor up-tick in M2 is not , at least for now, a major game changer.

Happy Trading,

Dave@TheMacroTrader.com

P.S.-Since M3 has been discontinued by the Fed we are now using the M3 data from NowandFutureswhich has reproduced it with a correlation of .99999 to the old M3 data.

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As of late we have heard a lot about how sentiment was too bearish and that this justified the market rally.  While we no doubt got a rally, we have to question the idea that sentiment is overdone to the downside.  In the world of sentiment indicators there are more then a few ways to look at things.  You can look at polls like Investors Intelligence or the AAII numbers, you can look at anecdotal indicators like covers at the magazine rack or listening to your shoeshine boy, and finally you can look at market derived indicators.

Looking at poll data alone would have you thinking that either the world is coming to an end or that we are due for a large counter sentiment trade.  The first chart here is of the Investors Intelligence Bulls to Bears ratio popularized by Marty Zweig.  As you can see in the chart it is hitting lows not seen since 2008.

Investors Intelligence Bulls Bears Ratio

If you want an equally extreme way to look at it below is a chart of the Investors Intelligence percent bears.  As you can see we are spiking to new highs not seen since the dark days of 2008.

Investors Intelligence Percent Bears

Looking at just these two charts makes the trend followers short and happy, and the contrarian leveraged long.  Of course we have a lot more tools at our disposal then just the Investors Intelligence poll data.  We like to check the poll based data against the market based data to see if it is inline with what investors are actually doing.  Usually it is, but sometimes it gets out of line.  As you can probably guess now is one of those times.  In the chart below we have taken the VIX and overlaid the percent bears.  As you can see both indicators usually move roughly to the same beat but lately the poll data has been getting more and more negative while the market derived data, data that actually shows where people are putting their money, has been getting more positive.

VIX and Investors Intelligence % Bears

Because of this disconnect we think that sentiment is not overdone to the bear side and that there is still some room to the downside.  In fact one of our short term sentiment indicators is showing exactly that as the 5-day equity only put call ratio hit .55 yesterday.  This level is significant as it has done an excellent job of showing when things are in fact too optimistic and has a good record calling tops in the equity market.  So while we aren’t calling for some Dow 1,000 crash, our analysis which includes sentiment data, does show room for more downside.

5-Day Equity Only Put Call Ratio

Happy Trading,

Dave@TheMacroTrader.com

Disclaimer-In our model portfolio we are long some SPY puts.

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