Money (volume) isn’t everything (for valuations)

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Money supply

There has always been a vocal minority in financial markets that argues that the key determinant of asset prices is the amount of money sloshing around. You can see why these “valuation monetarists” (a term we just invented) might think as they do. Here is a chart of annual changes in broad money (M2) plotted against the annual change in the level of the S&P 500. We’ve magnified the changes in the money series to show how, over many periods, stock prices track money volumes:

There are a lot of qualifications to be made here. There are plenty of possible explanations for this pattern other than simple causation. Which definition of money or liquidity you use matters a lot, and there is a lot that standard national measures such as M2 will miss, especially given that the financial system is multinational. And the velocity of money, not just the volume, ought to matter. But still, the monetarist intuition has a grip: push money into the financial system and financial asset prices will go up; suck it out and they will go down. Unhedged does not have a rigid house view, but we think some version of valuation monetarism probably holds, at least some of the time.

So we thought it might be useful to overview where the money supply stands now — focusing on M2, which comprises cash on hand, money in checking/savings accounts, and other short-term savings vehicles such as money market funds and CDs. After rising quickly from 2020 to 2022, when the Fed conducted quantitative easing, M2 fell in 2022 and early 2023 but has rebounded sharply. Is that supporting asset prices, or perhaps pushing them into bubble territory?

Consider what has caused the money supply to fall, then rise. From 2022 to 2023, high interest rates restrained bank lending (which creates money). At the same time, the Fed was engaging in QT, which, at least in its early stages, reduced the level of bank reserves held at the Fed, which can also restrain lending. But in late 2023 and 2024 lending picked up as the economy recovered, and it has been solid ever since. Surprisingly, perhaps, there was even a sharp rise in April, when the market panicked over Trump’s tariffs; Joseph Wang at Monetary Macro suggests this could have been because “disruptions in capital markets in April . . . caused borrowers to switch their financing to commercial banks”. Something similar happened during the pandemic.

An increase in the money supply driven by a sturdy economy and renewed bank lending doesn’t seem like an asset bubble-blowing machine. And indeed, if you look at M2 relative to GDP, it is now back almost to pre-pandemic levels. One could argue that even those levels were too high, a product of extraordinary monetary policy after the financial crisis. But the money supply has returned to a normal level without doing permanent damage to equity valuations. 

The Fed and the government could goose the money supply with monetary, fiscal and banking policies. But as of now, the resilient stock market is not an obviously monetary phenomenon.

Online sports betting

Last Friday, Illinois legislators tacked on a new tax on online sports betting apps to the state’s budget bill. It adds a levy of 25 cents per wager on the first 20mn online bets taken on each platform, and 50 cents on any further bets. This comes on top of the tax on gross gaming revenue (all money wagered minus the bettors’ winnings), the traditional form of casino taxation. 

The shares of the two largest publicly traded sports betting apps, DraftKings and Flutter (which owns FanDuel), fell 8 per cent and 3 per cent, respectively, on the news: 

If betting apps and app investors are feeling picked on by the tax authorities, Unhedged has this advice: get used to it. Online sports betting is a young industry, and it is unlucky to be growing at a moment when budgets at the state and federal level are under strain. Total gross gaming revenue for the US sports betting industry totalled $13.7bn in 2024, up about 25 per cent year over year, according to the American Gaming Association. Citi estimated that if Illinois’ new tax had been in place over the past 12 months, DraftKings alone would have provided Illinois with $68mn in extra revenue. The ultimate equilibrium state, Unhedged suspects, will be that the apps are taxed at a level that maximises tax receipts, while leaving enough profit for the apps to earn an average return on capital. Governments need the money and the apps are a soft target (and, unlike casinos, the apps can’t sell hotel rooms, fancy meals or tickets to shows on the side).

DraftKings and FanDuel will probably try to mitigate the impact of Illinois’ tax by passing it on to consumers, through reduced promotions or higher playing fees. For these companies, the top 1 per cent of users — heavy betters and sharks — generate about 25-50 per cent of app revenue, Jordan Bender at Citizens JMP estimates. But these customers may be more profit sensitive and migrate to lower-cost platforms. The higher-margin, reliable customer would then be the casual better out for a bit of fun. According to Bender, for these customers betting is:

more of an entertainment value . . . you sit down on NFL Sunday, you have $20 and you put it on a couple of games. It keeps you engaged. You’re kind of rooting for stuff you might not have otherwise. So that consumer, the general consumer, will almost likely always be there.

The online sports gaming industry might become, ironically, a competition to attract the low rollers. 

(Kim)

One good read

Connecticut Yankee in President Trump’s court.

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