Value and growth style investing (page 1 of 4)

US Stocks

The monetarists led by the Nobel laureate Milton Friedman believe that the changes in the stock of money exerted a powerful influence on the GDP, as well as on the level of prices. Since we live in a money economy, one can see how the flow of money affects the stock market movements.

The following is an observation of the Federal Reserve's policies on the banking system as a whole in relation to their loans and investments on one hand, and their deposits and liabilities on the other. Money supply may be considered as a measure of liquidity, it also depends on how much money supply has been created by loans, because all bank loans have to be paid off which reduces the money supply. A measure of liquidity is to take the bank deposits and deduct bank loans. The resulting series give a fair idea of how liquid the economy is and can be related to a number of economic series in terms of identifying stock market movements.

The Deposit/Loan ratio measures the health of the economy by the balance sheet position of its businesses. How efficiently capital was being employed, the aim is for the economy to come up with a healthy balance sheet while generating output that might well be free of excess inventory, which is non-recurring and even self-reversing. Thus it can also serve as an indicator for corporate earnings (with a 6-mo to 12-mo time lag).

In this study, the following factors were used: period: 1990 - 2000, S&P500 index, liquidity, Deposit/Loan ratio, quarterly corporate profits, Money growth M1

The bull run of the S&P500 started in 1992, when the following conditions were present:

- Bank liquidity were building up in the early '90s
- The extra cash not absorbed by the economy
- The D/L ratio was moving above the 1.2 level in '91
- Indicating corporate profit was growing
- By the beginning of '92, M1 hit double digit growth rate, and lasted until the end of 1993

The observations are as follow:
- Bank liquidity came from below $200 billion in 1973 to a peak of slightly over $500 billion in the month of Dec-92 coinciding with the D/L ratio

- Corporate profit was below $100 billon in early 1973, peaking at $832 billion in June-2000

- In 1994, liquidity started to decline but managed to stay near the $300 billion level. Profit growth in 1994 remained strong with D/L ratio above 1.1 level, but M1 growth started to trend down due to increasing Fed Fund rate, and the S&P500 ended the year lower

- 1995 & 1996 when lower and stable interest rates offset lower liquidity as loan demand picked up, and negative M1 growth rates. Furthermore, D/L ratio managed to stay near the 1.1 level indicating continued earnings growth

- The Fed fund rate was higher at the beginning of 1997,but the negative money growth rate began to moderate, and there was sustainable earnings growth as the D/L ratio stayed above the 1.06 level

- During 1998, liquidity continued to decline as loans picked up, the D/L ratio started to show weakness as it fell towards the 1.03 level indicating declining earnings. But M1 growth returned to positive growth, and the Asian crisis and LTCM brought relief in the form of aggressive Fed Fund rate cuts

- In 1999, liquidity continued to drop, especially after the Fed instituted its tightening policy in June, even as loan demand started to taper off. M1 growth started to shrink again. Despite the D/L ratio declining towards the 1 level, earnings were supported by Y2K related purchases

- Liquidity turned negative in the beginning of 2000 and for the first time since 1973, the D/L ratio fell below 1.