Gst, this pretty much sums up what I think.
>The Federal Reserve doesn't rely on interest rates alone to control the nation's money and credit, and some wary stock market forecasters think the Fed might still be tightening money growth, even as it keeps interest rates level for the time being.
There's a problem: How do we know what the Fed is doing?
In days of yore, everybody rushed to the wire to see the latest report on the money supply -- M1, M2, M3, etc.
But as economist Richard D. Rippe of Prudential Securities points out, the Fed has de-emphasized M1, and no longer considers M2 and M3 as reliable measures of money policy.
Most economists think the M's are just statistical noise.
And maybe the Fed is playing coy. "Publicly, the Fed downplays money growth, but could that downplay be a deliberate strategy?" wonders Eric T. Miller, a longtime market observer at Donaldson, Lufkin & Jenrette.
For the record, M1 is currency in circulation, commercial bank demand deposits and other checkable deposits such as NOW accounts.
M2 is M1 plus savings deposits, including money market deposits. M3 is M2 plus large-denomination time deposits, balances in institutional money funds, Eurodollars held by U.S. residents at foreign branches of U.S. banks and the like, explains Howard Roth of Investment Research, a money management firm in Rancho Santa Fe.
There is also MZM, or money of zero maturity.
No matter whether or not the M's are meaningful, there are some savvy analysts who think the Fed is holding back the money supply, systematically draining reserves from the banking system. That will have negative effects on the stock market, just as the easy money of last year -- meant to accommodate any Y2K panic -- helped drive stocks higher.
After all, Fed chairman Alan Greenspan has said that excessive stock market gains have spurred overexuberant consumer spending that he considers destabilizing. So while the Fed denies that it targets stock prices, it might be trying to hold back the gush of money that would push stocks up.
Doug Cliggott of J.P. Morgan says rapid money growth pumped up stocks in 1999 and early this year. Now, flat money growth suggests tougher times for stocks, he says.
Michael Cosgrove of the Dallas-based Econoclast newsletter is concerned about the same thing. "Money growth, which has been very easy the past few years, has turned tight," Cosgrove says.
He thinks M2 still has statistical relevance. And M2's growth is at a 5.4 percent annual rate. "That's slow relative to the 7 or 8 percent it had been growing," Cosgrove says.
He notes that consumer inflation has gone from 1.6 percent in 1998 to a 3.6 percent rate over the last 12 months.
"Part of this is energy, and the Fed can't do anything about that, but if it keeps growth of M2 at 5 percent a year, (and) if energy prices go up, prices of other products and services will have to go down," Cosgrove says.
And that, he says, "would affect the stock market negatively." When M2 was growing at 8 percent, there was money for the economy and the market. At 5 percent, there is only money for the economy.
Ironically, in the mid-1990s Greenspan said the stock market suffered from irrational exuberance, but he kept feeding that exuberance by pumping up the money supply, Cosgrove says. But now the spigot has been tightened. Investors beware.
E. James Welsh of Welsh Money Management in Carlsbad has his own Monetary Composite, but it does not include any M's. He has seven indicators, including such things as the difference between Treasury bill interest rates and the discount rate.
Now, his Monetary Composite tells him that the monetary situation is moderately negative. "The Fed is being modestly restrictive," he says. He has three-fourths of his portfolio in the stock market, but he is wary of a sell-off and could drop that percentage sharply.
"We don't pay attention to the M's," says Roth, a former economist with the Fed. Overall, however, "the Fed is definitely tighter than it was a year ago," he says.
Generally, Roth expects a good market over the next few years, but he doesn't see the 25 or 30 percent blue-chip returns that we enjoyed in the late 1990s. Blue-chip stocks will likely go back to returning around 10 percent a year, he says.
Looking at today's Fed, Tom Clutinger of Clutinger Williams & Verhoye says: "There is definitely a tightness there, but it's not dramatic. Money growth slowed up after the Y2K scare."
He thinks that the Fed won't raise rates further, that the economy will slow and that the market will enjoy a broad-based upturn. However, Clutinger also sees more modest returns. "Over the next five or 10 years, I expect a 9 to 10 percent average annual return (dividends plus capital gains)," he says.
The last five years of huge returns represented an anomaly, as did the inflation of the 1970s, Clutinger says.
The Fed might not pump money through the banking system as it did in the late 1990s. There will be less liquidity sloshing around. |
