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Money Supply (M1) and the Stock Market

Posted in Economic Indicators

A reader commented: “I couldn’t find an analysis for the M1 money supply similar to the one for M2. How about it? M2 cannot be an accurate money supply measure because it includes non-cash investments such as money market mutual funds. When the stock market corrects and people are exchanging stocks for say, money market mutual fund shares, the M2 figure will actually increase. The money supply is not literally increasing in such cases as no new cash is being created; there is merely an exchange of existing assets. Technically, only increasing the monetary base would increase the money supply, but M1 is a reasonable substitute for that as it includes the cash part of bank reserves.” The M1 money stock consists of funds that are readily accessible for spending: currency in circulation, traveler’s checks, demand deposits and other checkable deposits. Is there a reliable relationship between historical variation in M1 and stock market returns? Using weekly data for seasonally adjusted M1 and the S&P 500 Index during January 1975 through June 2016 (2,165 weeks), we find that:

The following chart depicts M1 and the S&P 500 Index on logarithmic scales over the available sample period. Both series have generally risen as the economy grows (and inflates), but the stock market is more volatile than M1. Visual inspection is not helpful in discovering any relationship between the two series.

To dig deeper, we explore lead-lag relationships between changes in M1 and S&P 500 Index returns.


The next three charts explore potential M1-stock market lead-lag relationships for non-overlapping intervals of one, four and 13 weeks over the entire sample period by offsetting changes in M1 relative to S&P 500 Index returns. Specifically,

The top chart relates weekly change in M1 to weekly S&P 500 Index return for offsets ranging from stock market return leads change in M1 by 13 weeks (-13) to change in M1 leads stock market return by 13 weeks (13).

The middle chart relates 4-week change in M1 to 4-week S&P 500 Index return for offsets ranging from stock market return leads change in M1 by six months (-6) to change in M1 leads stock market return by six months (6).

The bottom chart relates 13-week change in M1 to 13-week S&P 500 Index return for offsets ranging from stock market return leads change in M1 by four quarters (-4) to change in M1 leads stock market return by four quarters (4).

Correlations are generally small, and the lead-lag variations appear to be mostly noise. There are weak indications that: (1) a relatively weak (strong) stock market this quarter results in relatively small (strong) change in M1 next quarter; and, (2) a relatively small (large) change in M1 this quarter results in a relatively strong (weak) stock market two quarters hence.

Might there be exploitable non-linear effects of M1 variations on stock market return?


The final chart summarizes average next interval S&P 500 Index return by ranked fifth (quintile) of changes in M1 for non-overlapping measurement intervals of one, four and 13 weeks over the available sample period. Numbers of observations per quintile are 433, 108 and 33, respectively. Average returns do not vary systematically across quintiles. At a quarterly horizon, both the biggest drops and biggest jumps in M1 are favorable for the stock market.


In summary, evidence from several simple tests offer little support a belief that change in M1 money stock reliably predicts short-term or intermediate-term stock market behavior.

Cautions regarding findings include:

  • Analyses are in-sample using the entire set of data. An investor operating in real time may derive different views based on inception-to-date data.
  • Sample size is not large for the longest measurement interval, especially for the quintile breakdown.
  • Effects of M1 changes on the stock market may derive from level of surprise rather than level of change. However, determining level of surprise is problematic.
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