Is The Fed’s Current Policy Creating An Equity Bubble?
By keeping short-term rates at multi-decade lows, it is no secret that the US
Federal Reserve has been pumping money into the financial system in an effort to
stimulate economic growth to a self-sustaining level. So far, economic data is
confirming that a recovery is indeed underway and equity markets have responded
accordingly. Some market observers, however, are now arguing that the Fed’s
accommodative monetary policy is causing “easy money” to flow into the equity
markets, causing a new bubble to inflate. As such, I thought it might be useful
to address this argument by performing a very simple analysis of the money
supply and the Wilshire 5000 Index (which is the broadest measure of
the US stock market) in order to dispel any such concerns.
The most commonly used measure of the money supply is money with zero
maturity (MZM), which measures savings deposits, money market funds, physical
currency, and checking accounts. These components represent the most liquid
vehicles for money–that is, individuals can access their money quickly for
spending.
So far this year, MZM has grown by a hefty $376 billion, or 6.1%, and now
totals $6.5 trillion. And most of the growth has occurred in the savings
deposits, which are up 14% for the year. To be sure, consumers now have $3.2
trillion stored away in savings deposits–compared to $2.8 trillion at the end
of 2002.
Let us next consider the value of MZM relative to that of the stock
market in order to determine if the stock market is forming a bubble due to
increased liquidity.
If one considers that the 13 year average of MZM as a percentage of the
Wilshire market cap is is about 54%, then the stock market is not currently
overly inflated. To be sure, the amount of money in MZM is about 68% of the
Wilshire 5000 market cap. By comparison, at the height of the equity bubble in
2000, total MZM was 29% of the Wilshire market cap, and at the stock market lows
last October, the relationship was 78%.  Â
Moreover, one could argue that bonds have been the bigger beneficiary of
increased liquidity–not equities. For example, net inflows into bond funds for
2003 now total $85 billion, whereas equity funds have only received $70 billion.
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