Under-the-radar trend may provide relief from runaway inflation fears

A long-time bull is seeing an under-the-radar trend that should allay runaway inflation fears, and that has nothing to do with Federal Reserve policies.

According to Jim Paulsen of the Leuthold Group, private money from individuals and corporations has acted as a “very encouraging” market mechanism to contain inflation.

“We make decisions about whether to save or spend. We make decisions about whether or not to borrow money. And it all affects the growth rate of the money supply, ”the company’s chief investment strategist told CNBC’s“ Trading Nation ”on Monday. “While we are still debating when the Fed might start tightening … the reality is that the money supply in this country has now been decreasing for the past four months.”

Paulsen, who manages around $ 1 billion in assets, highlights the trend in a special graph. It shows the relationship between consumer price inflation and the money supply since 1990.

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“The real money supply M2 [total amount of dollars held by the public] Peaked at the end of February with a year-on-year growth rate of 26%, ”said Paulsen. “It was down around 8.5% at the end of May, and it is likely lower than when the June numbers were released. “

Paulsen estimates that the growth rate and real liquidity have decreased by about a third.

“When you put this graph of real money supply over the rate of inflation, it’s not a perfect relationship,” he noted. “But there is certainly a strong correlation in which periods of significant declines in money supply often lead to slower inflation rates in the future.”

What a difference two months make.

At the “Trading Nation” in April Paulsen rated uncontrolled inflation as his greatest risk to the market and estimated the probability of uncontrolled inflation at around 40%.

“The returns go so far that they drop”

Despite his current optimism about mitigating inflation risks, Paulsen continues to expect the benchmark yield on 10-year government bonds to rise. Yields closed at 1.48% on Monday, down more than 11% over the past three months.

“Returns are almost complete. We will continue to receive really strong growth reports,” he added. “We have another fiscal package ahead of us and I think that will allay inflation fears and strong real GDP growth that will push yields back towards 2% by the end of the year.”

His expectation: higher yields will create headwinds for stocks in the second half of the year, especially for growth stocks.

“People are concerned about the tightening of monetary policy and the market is going through some kind of pause and I think we are in that phase right now,” said Paulsen. “We often have corrections during these periods and I think we’ll get one of them later this year too.”

He predicts the S&P 500 will hit 4,500 before dropping to 4,100 by the end of the year. On Monday it closed at 4,290.61 – an all-time high. So far this year it’s up 14%.

“[If] The market ends flat or a little lower than we are now, we will start 2022 with a stock market with a trailing P / E that is undervalued compared to its history through 1990, ”Paulsen said. It prepares the bull’s next leg. “

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