This is an interesting graph.
Top Chart: Rolling 12 month returns on the S&P 500
Bottom Chart: Monetary Supply (M2) divided by Industrial Production (IP)
The bottom chart is meant to imply if money supply growth is outpacing industrial production. In other words, when this index spikes (as it did in 2002 and in 2009) this means that the monetary supply is increasing due to Federal Reserve actions and this is not finding its way into the real economy. We take the decline both in both instances to represent when money growth found its way into the real economy and industrial production “caught up” with policy actions.
We think this is a positive for markets. Clearly the original impulse response (12 month return on the S&P was over 40%) is over. Now markets are in Act II, and clearly recent news from the European debt crisis imply we are in for a mid cycle slowdown. A slowdown does not imply the market and economic recovery is over. As was evident in 2003, markets rallied like crazy from their bottom, formed a stable base that finally gave way to a new bull market.
Economic fundamentals and the corporate profit picture points to a healthy recovery, even though recent market action would imply the opposite. What is going on in Greece is not pretty, and it could easily cascade to less important economies (Hungary) as well as more important economies (Spain). Just like a household that is having trouble paying its debts should not take on more debt to be able to pay its interest payments, global central banks should not throw more debt at a problem caused by too much debt.
Tags: Industrial Production, IP, M2, Money Supply