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Money Supply (M2) and the Stock Market

Posted in Economic Indicators

Some investing experts cite change in money supply as a potentially important driver of future stock market behavior. When the money supply grows (shrinks), they theorize, nominal asset prices tend to go up (down). Or conversely, money supply growth drives inflation, thereby elevating discount rates and depressing equity valuations. One measure of money supply is the M2 money stock, which consists of currency, checking accounts, saving accounts, small certificates of deposit and retail money market mutual funds. Is there a reliable relationship between historical variation in M2 and stock market returns? Using weekly data for seasonally adjusted M2 and the S&P 500 Index during November 1980 through June 2016 (1,861 weeks), we find that:

The following chart tracks M2 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 far more volatile than M2. Visual inspection is not helpful in discovering any relationship between the two series.

To dig deeper, we explore lead-lag relationships between changes in M2 and S&P 500 Index returns.


The next three charts explore potential M2-stock market lead-lag relationships for non-overlapping intervals of one, four and 13 weeks over the entire sample period by offsetting changes in M2 relative to S&P 500 Index returns. Specifically,

The top chart relates weekly change in M2 to weekly S&P 500 Index return for offsets ranging from stock market return leads change in M2 by 13 weeks (-13) to change in M2 leads stock market return by 13 weeks (13).

The middle chart relates 4-week change in M2 to 4-week S&P 500 Index return for offsets ranging from stock market return leads change in M2 by six months (-6) to change in M2 leads stock market return by six months (6).

The bottom chart relates 13-week change in M2 to 13-week S&P 500 Index return for offsets ranging from stock market return leads change in M2 by four quarters (-4) to change in M2 leads stock market return by four quarters (4).

Correlations are generally small and appear to be mostly noise, except for small negative contemporaneous values. In other words, the stock market tends to be relatively strong (weak) when changes in M2 are relatively small (large). Given the several-week delay in availability of M2 data, it appears very unlikely that M2 changes are useful trading signals.

Might there be exploitable non-linear effects of change in M2 on stock market return?




The final chart summarizes average next interval S&P 500 Index return by ranked fifth (quintile) of changes in M2 for non-overlapping measurement intervals of one, four and 13 weeks over the available sample period. Numbers of observations per quintile are 372, 93 and 28, respectively. Average returns do not vary systematically across quintiles. Large drops in prior-interval M2 are perhaps unfavorable for the stock market.


In summary, evidence from several simple tests offer little support for belief that change in M2 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 M2 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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