#37 S2N: Money Supply

I am going to experiment a bit with the format of the newsletter. I learn so much from feedback, so please let me know if you think this is an improvement. Essentially, I am going to focus on one main signal a day. I have placed a section at the bottom called “Observations,” where I can drop a chart, table, or comment relating to something that has caught my attention but will not be the focus.

There are some sections I am working on that will also be included in the newsletter as I make further progress. One of the benefits of age and experience is that you get to meet smart, good people over time who are wonderful sources of guidance and personal development.

Recently, I got conflicting advice to keep personal opinions and too much backstory out of the letter. I love writing and I am also known for not having a filter so I have been diligently holding back. The argument, on the one hand, is that my stories and opinions are not adding value and possibly contributing to noise, which is a cardinal sin in an S2N world. On the other hand, the stories and opinions give the letter personality and perhaps are part of my unique selling feature that differentiates me from competitors.

So I will try to find some common ground. The reason I am writing so late today is because one of the kernels of a virtual environment on my computer got corrupted. For those of you who are interested,the kernel is a computer programme at the core of a computer’s operating system and generally has complete control over everything in the system. The kernel is also responsible for preventing and mitigating conflicts between different processes. Sadly, one of the libraries I updated corrupted the kernel, and I have spent the last 24 hours trying to figure out the problem. There is good news I solved it so here goes.

Today’s Spotlight

M2 is the U.S. Federal Reserve’s estimate of the total money supply, including all the cash people have on hand plus all the money deposited in checking accounts, savings accounts, and other short-term saving vehicles such as certificates of deposit (CDs). Retirement account balances and time deposits above $100,000 are omitted from M2.

If you have studied economics, you will have come across Milton Friedman’s famous quote: It is always and everywhere, a monetary phenomenon. It’s always and everywhere, a result of too much money, of a more rapid increase in the quantity of money than an output.

As you can see with the blue line below, M2 has climbed to over $20 trillion but has more recently been declining.

In the chart above, you can see, with the orange line, that the year-on-year growth in M2 money supply shot up with COVID to above 25%. With inflation finally showing up, the Fed was forced to start draining money supply and you can see how growth has collapsed into negative territory. We have never seen negative growth before. When you look at where we got to, you realise how much work was needed. It is just hard to believe it is all over already. Usually, when moves are so violent, things are broken.

For the sake of completeness, I wanted to share a backtest where I use 0% as the threshold for a market timing strategy. This is actually an extremely naïve strategy. I have run out of time for today, so I am going to send the simple version today. Tomorrow, I will spend some time fine-tuning a more useful strategy.

Performance Review

To learn a bit more about the Z-Score, which I use for the colour signals, read this blog post.

Chart Gallery

Observations

Gold is continuing to climb to new highs. The 10-year US Treasury is also steadily climbing higher at 4.42%; if it takes out last year’s 5% highs, we are in trouble.

Not to be ignored, the yen is breaking out to new 30-year lows. The BOJ of Japan is going to struggle to defend it like they have suggested.

The reason I say the BOJ will struggle is because of their inflation. The Bank of Japan was amongst the most aggressive of all central banks. As you can see, the BOJ’s balance sheet is still at an all-time high. This has helped lift Japan out of a multi-decade era of deflation. The aggressive quantitative easing resulted in a weakening currency, which was good for the economy as it stimulated export growth through manufacturing. So jobs were not an issue. Inflation is now a problem, and a weaker yen will add to this problem. If I were to trade this pair over a shortish time frame, I would expect to see it breakout higher.

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