Stocks tend to move with global liquidity. In other words, if there’s an abundance of money in the system, it is very likely that stock market prices climb higher. After all, many investors will look into assets that can help them quickly grow their capital.
On the other hand, a liquidity squeeze is likely to drive equity prices lower. That’s because buyers are needed to push prices higher. If market participants become illiquid, selling pressure builds and sends prices into a free-fall.
Economist Holger Zschaepitz elegantly captures this market dynamic in a tweet.
This is why we’ve been warning our readers that we’re facing a global dollar squeeze. Follow the money and you’ll likely know where the stock market is headed. Our research revealed that the money supply has been declining for years.
The S&P 500 is currently struggling to breach its all-time high. According to Twitter user Downtown Josh Brown , the index has been flat over the last 18 months.
While this behavior might be seen by bulls as consolidation in preparation for new highs, it can also mean that the market is running out of steam. If you consult the monetary base, you will realize that the latter appears to be the case.
The chart above shows how the S&P 500 soared in tandem with money supply from 2012 to 2014. However, towards the end of 2016, the two showed signs of divergence. The SPX continued to climb while the monetary base dwindled.
Currently, the gap between the two is so wide that it no longer looks sustainable. Either monetary base expands or the stock market has some catching up to do.
We spoke to economist Alex Kruger to confirm our stance. Apparently, we’re on the right track. The analyst said,
Lower money supply translates into lower stock prices whenever it doesn’t reduce inflation / create deflation. When it does, it can go both ways, though it usually does lead to lower stock prices.
He added,
A growing economy has a positive demand for money. In a well functioning economy, money supply growth should satisfy the growth in the demand for money. Starve the economy from money, and this should result in diminished growth. Real growth is one of the drivers for stock prices.
It appears that the growing American economy is no longer producing the required monetary growth. Thus, there’s evidence to suggest that it’s likely that the stock market may crash.