Velocity Pivot Good for Stocks
During the greatest bull market in history from 1987- 2000 when the S&P 500 gained 582%, the velocity of money increased steadily (arrow 1 below). Increasing velocity has coincided with most expansionary periods. Not the case in this bull market. Since 2010, the velocity of money has fallen unceasingly (arrow 2 below) and is resting at the lowest level since 1959. From the third quarter of 1997, the velocity of money is down 35%.
What is the Velocity of Money?
The U.S. Treasury infuses dollars into the economy. A new dollar spent on a good or service is often reused to buy another good or service. The same dollar keeps buying goods and services until either it wears out or is held in savings. Measured over a period of time, the number of times a dollar changes hands is defined as the velocity of money. It is a gauge of the economy’s strength.
During recessions (shown by gray bars), the velocity of money tends to decrease (the exception being 1974), since the amount of transactions in an economy decreases. Consumers tend to save more and firms tend to invest less—that is, they hoard cash. In general, the velocity of money starts to increase after a recession, when confidence is restored.
Why is velocity falling while the economy is expanding?
Economic relationships are complex and there is no single, simple answer. One reason the velocity of money is so low currently is because many dollars are never making it into the hands of consumers. Banks have tightened lending standards and are stockpiling dollars at the Federal Reserve. We wrote about this in last week’s newsletter, How Safe Are the Banks? As a follow-up and in response to several comments, we will use the same chart again to drive home the point. The chart below shows the currency in circulation (orange line) has been steadily rising since 2007 but bank deposits at the Federal Reserve have jumped from $20 billion to roughly $2.3 trillion.
The dramatic decrease in interest rates is another reason. Short term rates have been at or near zero for a large part of the past eight years. Extreme low rates caused investors to hoard cash instead of spend it – an unintended consequence. Below is a chart of historical treasury rates for short term (1-month) bonds.
Banks will migrate from survival mode the further we move away from the financial crisis to a growth mode whereby they will increasingly make loans to drive profits. Individuals will put money to work as interest rates rise. The huge reservoir of capital available to enter the economy and a velocity pivot have the capacity to extend the growth cycle for years. From such a low velocity level, there is plenty of room to run. We end this week with a continuation of our bullish view on equities.
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This commentary and previous editions are available as PDFs:
3/3/2017: Velocity Pivot Good for Stocks
2/24/2017: How Safe Are The Banks
2/17/2017: Climbing A Wall of Worry
2/10/2017: Value Shopper - Europe on Sale
2/3/2017: What, Me Worry
1/27/2017: Extraordinary Earnings Louder Than Trump
1/20/2017: It's Not All About Trump
1/13/2017: I Gotta Feeling
1/6/2017: Finally, A Case for International in Your Portfolio
12/30/2016: Predicting the Future -2017
12/23/2016: Bullish New Year
12/16/2016: All I Want For Christmas is Financial Independence
12/9/2016: Debt Trap
12/2/2016: Trade What Is, Not What You Think It Should Be – 2017 Outlook
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