Does Dropping Money Velocity Mean The Rally Will Reverse?
A frequent theme on Zero Hedge is the structural limitation imposed on corporate revenue and profitability absent an overall increase in the currency in circulation, or said otherwise, in the "velocity" of money. If banks do not lend out the money, and the money does not somehow find its way to companies' top lines, there is logically less revenue thus lower EPS (especially with the key layoff rounds already having taken place). We were gratified to see Rosenberg pick up on this theme in his latest "Latkes with Dave" piece. As Rosenberg points out, the banks continuing unwillingness to lend money out will end up transforming not only the political landscape in D.C., but could very easily be the end of the seemingly endless bear market rally.
Chart 1 maps out the S&P 500 with money velocity (GDP/M1 ratio). There is a 90% correlation between the two. It is one thing to have the Fed pump liquidity into the system but it is quite another for the liquidity to be re-leveraged into credit and recycled into the economy.
The Fed’s easing program is over two years old and the rampant Fed balance sheet expansion 15 months old, and still to this day, what the commercial banks have done (to Obama’s wrath) with all that liquidity is to keep it as cash on their balance sheet to the tune of $1.2 trillion. We’re not sure why Obama is as rankled as he is because the banks are in fact lending out a good chunk of that Fed-induced liquidity — right back to Uncle Sam (the banks now own a record $1.3 trillion of government securities).
Back to the chart — there is obviously a close connection between money turnover and the stock market. But we can get periodic divergences as we did in the first leg of the rally in 2003. But the carry-through from 2004 to 2007 hinged critically on that multi-year acceleration in money velocity. If we don’t see the banks begin to extend credit in 2010, it is hard to see the 2009 bounce from oversold lows as being sustained in the coming year.
On the other hand, money velocity is closely tied to general availability of credit. So the long-term chart could be simply falsely correlating two indirect derivatives of a broader systemic issue over the past 20 years: Greenspan's ever cheaper and abundantly available credit. In other words, if banks do not loosen up their "stingy" ways (which of course was the very reason why we are in this place to begin with), before the Fed tightening begins sometime in 2010/2011, then one can kiss the idea of money velocity increasing goodbye.