The Invisible Hand That Actually Moves Your Portfolio: Money Supply vs. Assets Value

For many of us who have spent years navigating the Singapore and regional markets, we often get bogged down by the "noise." We look at quarterly earnings, we obsess over whether a REIT's occupancy dropped by 1%, or if a company’s CEO had a bad day during an analyst call. But after decades of investing, I’ve realized there is a much bigger tide at play. It’s not just about the ships; it’s about the water level.

In economics, we call this the M2 Money Supply. In plain talk, it’s just how much "stuff" is circulating in the system. When the taps are open, everything feels like a genius-level investment. When the taps close, even the best companies struggle to keep their heads above water. Let's peel back the layers on how this liquidity truly dictates the price of our assets.

<Image credit:www.econovis.net>

Why "Inflation" Isn't Always What You Think It Is

When most people hear "inflation," they think about the price of chicken rice or Cai-png going up at the hawker center or the electricity bill hitting a new high. That’s consumer inflation (CPI). But as investors, we need to look at the relationship between the money supply and company profits.

When a central bank prints more money, that currency essentially becomes "diluted." If you have 100 oranges and $100, each orange is $1. If I suddenly print another $100 but we still only have 100 oranges, the price naturally moves toward $2. This is the simplest way to view inflation.

<Image credit: Creative Planning @PeterMallouk>

Now, how does this affect the companies we own? Many people assume inflation is bad for business. In the short term, yes, costs for raw materials and labor go up. However, for companies with a **strong moat** (think of the big telcos, dominant REITs, or consumer staples), they simply pass those costs on to us.

If a company’s revenue grows by 10% because they raised prices, but their costs only went up 8%, their "paper profit" actually looks better. This is why, during periods of high money supply, the stock market often goes up even if the "real" economy feels sluggish. The profits are being measured in a currency that is becoming worth less every day. We aren't necessarily seeing companies become more efficient; we are seeing them capture the excess cash flowing through the system.

The Magnetism of Liquidity: Stocks, Gold, and the New Players

<AI image>

If you look at the data from 1970 to now, the correlation between Global M2 and the S&P 500 is almost uncanny— around 0.94. That is almost a perfect shadow. When the money supply expands, assets with a finite supply act like magnets for that cash.

 * **Stocks:** They represent ownership in productive assets. As more money chases a limited number of high-quality shares, prices rise. It isn't always about "value"; sometimes it's just about "volume."

 * **Gold:** For the "old guard" of investors, gold is the ultimate hedge. It doesn't pay a dividend, which usually turns me off as a value investor, but you cannot "print" more gold. Historically, when M2 surges, gold eventually follows because it is a fixed-supply alternative to "melting" fiat currencies.

 * **Alternative Assets & Crypto:** In the last decade, we’ve seen the rise of Bitcoin and other digital assets. Regardless of whether you believe in the Blockchain tech, from a statistical standpoint, crypto behaves like "high-beta" liquidity. It is essentially an orange juice concentrate of the money supply. When M2 is gushing, crypto flies. When the Fed or other central banks tighten the belt, it’s usually the first thing to drop.

The lesson here? You don't just own a stock; you own a claim on a piece of the world that is priced in a currency the government can create at will.

When the Party Gets Too Loud: The Stock Bubble

This is where things get dangerous. In a perfect world, the stock market would grow in a nice, straight line alongside the money supply ( companies earnings) . But human beings are emotional. We have greed, and we have fear.

When the money supply grows steadily, we eventually get "exuberance." This is where the price of the S&P 500 (or any index) starts to detach from the M2 trend line. I call this the **Valuation Gap**.

Think back to the year 2000 or even the recent "AI boom." If the money supply grows by 5%, but the market jumps by 30%, we have a problem. That extra 25% isn't backed by liquidity; it’s backed by "hope" and "leverage."

Some analysis shows we are sitting in one of the largest gaps in history, roughly **76% above the liquidity trend.** This doesn't mean a crash happens tomorrow, but it means the "elastic band" is stretched very thin. In 2008, the market fell so hard it actually went *under* the money supply line, becoming significantly undervalued. Today, we are at the opposite end. We are paying a massive premium for the future, far beyond what the current money supply justifies.

The Printing Addiction: Why Market Cycles are Getting More Violent

The reality we’ve lived through since the 2008/09 Global Financial Crisis is that governments and central banks seem to have developed a permanent "addiction" to liquidity. Whenever the economy hits a speed bump, the immediate reflex is to open the monetary taps. This policy of "printing money" to solve structural problems has fundamentally changed the DNA of the markets. We’ve moved away from a world where prices are discovered by corporate earnings and moved into one where prices are dictated by the size of the central bank's balance sheet. When you flood the system with excess liquidity, you aren't just supporting the economy; you are creating a "boom and bust" cycle that is now more aggressive than ever.

<Image credit:CrossBorderCapital.com>

This constant injection and subsequent withdrawal of cash have made asset prices incredibly sensitive and volatile. If you look at the charts over the last 15 years, you'll notice that the old "slow and steady" market cycles are gone. Instead, we see wild swings and "V-shaped" recoveries. Because there is so much "fast money" sloshing around, any hint of a downturn is met with a massive wave of intervention, causing market corrections to become incredibly short and sharp. It’s like a rubber band that is being pulled further and faster each time; the snapback is more violent.

For us as investors, this means the environment has become a lot more "noisy." One day the market is crashing due to a liquidity scare, and the next, it’s hitting record highs because a new stimulus package was announced. This volatility is the price we pay for a market that is no longer decoupled from government intervention. We are seeing asset classes,from tech stocks to property,swing wildly not because the underlying value changed overnight, but because the "monetary tide" rose or fell in a matter of weeks. In this "addicted" economy, the risk of a burst is always lurking behind every boom, making it even more crucial to focus on fundamental quality rather than just riding the waves of cheap money.

The Hidden Risk of "Playing it Safe": The Melting Cash Cube

<Image credit:Monevator.com>

https://monevator.com/cash-total-returns-a-long-run-index-for-diy-investors/

"Cash total returns: a long run index for DIY investors"

There is a common misconception among conservative investors that cash is the ultimate "risk-free" asset. We feel secure when we see a healthy balance in our savings account, especially during volatile market swings. But the chart above tells a much more sobering story, one that I call the "Cash Crash." Since 2009, holding onto excess cash hasn’t just been a missed opportunity; it has been a guaranteed way to lose wealth. When you factor in the relentless march of inflation, that pile of cash in the bank is actually a melting ice cube. By mid-2023, the real value of cash had drawn down by a staggering 15%. This is the silent predator of the financial world; it doesn't scream like a stock market crash, but it erodes your lifestyle just as surely.

This creates a painful predicament for many. 

We are stuck in a dilemma: if we jump into the market when it’s "overvalued" relative to the money supply, we fear a correction. But if we sit on the sidelines in cash, we are essentially guaranteeing a loss of purchasing power every single day. This is the "cash trap." You think you are protecting your capital, but you are actually watching its "real" value evaporate. Inflation doesn’t care about your need for safety; it only cares about the expansion of the money supply. As governments continue their addiction to printing, the currency in your pocket is being systematically diluted.

The only way out of this predicament is to move from being a "saver" to being a "holder of hard assets." This is why I emphasize equities, REITs, commodities, and even gold. These aren't just vehicles for profit; they are essential lifeboats. High-quality companies have the "pricing power" to raise their fees or product prices as inflation bites, effectively acting as a natural hedge. When you own shares in a dominant business, you own a claim on a productive asset that keeps pace with, or exceeds, the rising tide of money. In a world of infinite currency and finite assets, holding too much cash isn't "safe", it’s a slow-motion disaster for your long-term retirement. The real risk isn't the market's volatility; it's the certainty of cash becoming worthless over time.

Final Thoughts: Staying Grounded in a Liquidity-Driven World

So, what do we do with this information? Do we sell everything and hide under the bed? Of course not. Understanding the money supply doesn't mean we stop investing; it means we change *why* we invest.

The reality is that as the money supply expands, **currency depreciation** is almost an inevitable side effect. When there is more money chasing the same amount of goods and services, the purchasing power of your hard-earned savings in the bank slowly melts away. This is why inflation is often called the "silent tax." If you hold only cash, you are essentially holding a melting ice cube while the global monetary base continues to swell. This is the "dilemma" or predicament of holding too much of cash instead of having "hard asset or Equity" in a inflationary environment.

This is exactly why we must remain long-term equity investors. High-quality stocks aren't just tickers on a screen; they are ownership stakes in productive businesses that have the power to raise prices as the currency devalues. In this sense, **equity acts as a vital hedge against inflation.** While the "valuation gap" tells us to be cautious about *what* price we pay, the long-term trend of the M2 supply tells us that staying out of the market is often riskier than being in it. You want to own assets that grow alongside the money supply, rather than holding the very currency that is being diluted.

As a value investor, my goal has always been about **preservation and yield.** But understanding the money supply helps me stay humble. When my portfolio is up 20% in a year, I have to ask myself: "Is my company 20% better, or is my money 20% cheaper?"

We are currently living through a period of "liquidity stretching." The AI narrative is powerful, and the companies involved are truly changing the world, but the *prices* we are paying are being pushed up by a very specific type of global liquidity. My advice is the same as it has been for years: look for the companies that can survive when the "tide" goes out. Look for the ones with the cash flow to pay you dividends even when the money supply flattens. Because if history teaches us anything, it’s that the regression line is a magnet. Eventually, the market always comes home to the reality of the money supply.

<Image credit: Refinitiv_Datastream>

Keep your buffers ready, don't over-leverage, and remember that in the long run, the "house" (the central banks) always dictates the stakes of the game. We are just playing at their table.

Stay safe and invest wisely.

Till next update...

Cheers! 😊

STE