Being the bearer of bad news is never fun. However, in this short post, I want to go over a chart that is hiding crucial information in plain sight. An inflation-adjusted SP500 chart. As a quantitative trading expert I can attest that statistically, simple technical analysis patterns work. The data is there to support this claim. And this chart shows some crucial technical points that are rather invisible until you adjust things to inflation.
- Adjusting S&P price to inflation gives a very different picture of the economy
- The current recovery after the pandemic is a mere pullback in a larger downtrend trajectory
Calculating money amounts in the world is a rather complex and interesting topic. In the financial world, the term “M” was coined to define various types of amounts of money circulating on the planet. It is assigned into 4 groups starting from M0 and going up to M3. The M2 is the most common one that is broad enough to define the liquid amount of money in circulation. M2 includes cash, checking deposits, and easily convertible near money and is widely used in the financial world as a factor of inflation.
The efficient market hypothesis is absolute philosopher derived BS – technical analysis patterns work. The data is there to support this claim.
Obviously, there is no financial instrument that would let you trade or at least see the inflation-adjusted SP500 price. However, thanks to the wonders of technology over at tradingview we are able to simulate this by plotting an S&P price divided by the M2 amount of money. The above image is exactly that – a monthly chart of SPX divided by the chart of the M2 money supply. So in a sense, this is a chart of (at least in part) an inflation-adjusted S&P index.
Below we see this chart side by side with a regular S&P chart.
There are three key points I want to make while looking at this chart to spark a thought.
- Non-technical – the S&P recovery after the initial hit in 2020 was lightning fast. The index price is hitting new all-time highs as you read this, even though we can feel the economy is not yet recovered, the unemployment rate is very high, and people are becoming more conservative which means less money circulating the markets. That always raised suspicions, but shorting the S&P is a risky game that I usually loose, so until now, I was not sure what to think and was just monitoring on the sidelines. However, after adjusting the price for inflation, it is obvious that the recovery to all-time highs is nothing more than a pullback in a larger downtrend move, as we can see from the first chart.
- Technical – this pullback is actually at a very crucial technical level, almost hitting the 12 bar EMA resistance from below. Likely, we will still see some upward movement in the following few months. Solely basing this comment on this single isolated event of EMA 12 resistance, one could speculate that we may start seeing the beginning of the following (larger) downward movement sometime around the end of fall 2020 (keep in mind this is a monthly chart). Something very similar happened in 2008 if you take a look at the first chart. After the initial hit, there was a small pullback into the EMA12 level, after which we saw the subsequent collapse of the economy.
- Of course, psychologically the first hit is the hardest for the population, the same was in 2007-2008 the same is now.
- The following large move down in the inflation-adjusted S&P price might be impacted by the combination of 2 factors.
- Drops in the index price.
- Increase in inflation.
Keep this in mind when searching for opportunities to make money of this time of economic uncertainty
- Technical – looking at the inflation-adjusted price we can see that the collapse of the index happened at a very significant resistance level that was high in 2008. This is a strong technical resistance indication that is otherwise invisible if you don’t adjust the price to inflation. Seeing this just strengthens the doubts about the actual economic recovery that we are seeing as breaking such a resistance level would require a very strong upward movement which is unlikely to happen.
Making actual trading decisions from this analysis may not be very straightforward as the M2 adjusted S&P is not a tradeable financial instrument, however, this alternative view gives us crucial insights into the fake economic recovery we are seeing. It is hard to say what will cause the following economic struggle – whether it will be the following developments in constraints country leaders are putting on their citizens to help fight the virus or maybe large bank(s) will screw something up again like in 2007-2008. New information keeps hitting our doors about malpractices of banks, which makes you wonder if the 2008 economic collapse was properly resolved.