How Much Money Is In The System? by Bargain Value

Some people like to hold money in bonds or time deposits. Others prefer mobility over interest and they choose cash. Today, we will learn about how to predict moves of the stock index, looking at which one of this two group is becoming stronger.

We can divide money supply in a few groups:

  • Quick group – contains the money, which we can spend almost immediately. Cash and call deposits,
  • Average group – contains short-term deposits and other instruments, which do not bind our capital for more than 3 months,
  • Slow group – contains long-term deposits and bonds, which bind our capital for even 2 years.

National banks(e.g. Bank of England) count how much money is in each group. They call them money aggregates(M1, M2, M3, M4). We will focus on the M1 aggregate. It measures „physical money”, such as coins and currency, call deposits and checking accounts. They are the most liquid components of money supply; cash we can spend and assets we can quickly turn into cash.

Our idea is to measure the dynamic of M1 aggregate, which tells us if the amount of “quick money” rise or fall. Why is it important? We think, that falling level of M1 indicates that people prefer to save(e.g.  long-term deposits) and invest(e.g. buy shares). The banks have got more money, so they can offer more credit to the companies. The companies can invest because they are well-funded. These actions stimulate the whole economy, which can be seen as the rising index of FTSE SMX. We chose this index, because it is less volatile to sudden information, which often brings down or up main indexes.  You can see the results on the chart below:

How Much Money Is In The System

If the blue line is high, the people prefer to hold money in cash, otherwise they choose deposits with interests, bonds and other less liquid assets.

How Much Money Is In The System

Let’s see if this strategy is correct. The chart below shows the change in FTSE SMX during one year after  the four bottoms.  We excluded the bottom marked with black arrow(March 2007), because it is high above average of M1 dynamic( avg. 8,8%). It was a false signal.

How Much Money Is In The System

The courses of four green lines prove, that the index rises after the period, in which people do not prefer to hold „quick money”.  Summering, in 4 out of 5 cases the very low level of M1 dynamic was a good sign indicating boom on the market. On average, the index gives us 30% return after 12 months. Our theory from the beginning of this article is correct and effective.

At the moment, we are after a peak in M1 dynamic in March 2014 and we can see, that FTSE SMX is slowing down. The correction is quite probable. The current level of M1 dynamic (6,91%) is not telling us much. We must wait and see how this indicator will behave in the near future. If it forms a bottom, it will be a very good growing sign, because the previous ones was good too. If it happens we can expect returns from 16% up to 50%.

Intervals between bottoms are not regular:

  1. 4 years and 9 months
  2. 4 years and 3 months
  3. 2 years and 9 months
  4. 1 year and 9 months

In this situation, it is hard to predict the moment, when the next bottom will appear. Changes in M1 are very dependent on monetary policy (levels of interest rates, additional printing of money etc.), which is the reason of such irregularity.

Despite this fact, tracking M1 dynamic is still very good strategy, which gives us a fair profit.