Wouldn’t it be great if we had an indicator telling us whether the stock market is relatively under-priced (i.e. cheap) or over-priced (meaning we might be in a bubble) at any given time? That’s why we have built ekwy.com.
There are many indicators commonly used by investors to analyze and predict stock markets return, Price to earnings ratio (P/E) being the most popular one.
Unfortunately, P/E is not a very reliable indicator and despite managing to indicate the over-priced markets around the year 2000, it failed to predict the subsequent recovery etc.
Money supply vs stock market
In his book (unfortunately not available in English), Pavel Kohout noticed that there is a strong correlation between money available in the economy and the value of the Dow Jones Industrial Average index (DJI).
Mr. Kohout found out that Money with zero maturity (MZM) worked best in representing the money supply and presented a simple way of calculating the coefficient between the money supply and stock market index using linear regression.
Both DJI and MZM data are publicly available so after finding (now defunct) akciomer.com website, we have decided to develop similar application using the correlation principle described in the book.
The application automatically retrieves all necessary data, does the calculations and presents a single chart.
Understanding the chart
The following picture explains how to read the chart:
The blue line represents price of stock (stock market index). The orange line represents the calculated equilibrium. In other words, the orange line shows what we believe would be a fair price of stock given the amount of money available in economy at a certain point.
So whenever the stock price is under the equilibrium line, we consider stock to be under-priced. Similarly, if the stock price is above the equilibrium, we say the stock is over-priced (indicator of potential bubbles).
The under- and over- valuation can also be seen as green and red ares, respectively.
By clicking into the chart and dragging your mouse, you will zoom in and see more details.
Supported markets and commodities
Using the ‘Stock Market’ chooser, you can pick between the following data sources:
- DJI 30 – The Dow Jones Industrial Average Index is computed from the stock prices of the 30 largest and most widely held public companies in the United States
- NASDAQ 100 – The NASDAQ 100 is a stock index of the 100 largest domestic and international IT, electronics, biotechnology & telecommunications companies listed on the NASDAQ Stock Exchange (USA)
- S&P 500 – The Standard & Poor’s 500 is a value weighted index of the prices of 500 large capitalization common stocks actively traded in the United States
- Silver – The London Silver Fix
- Gold – Bundesbank Gold Prices
We might be adding more stock markets and commodities in the future. Let us know your preferences.
Even though the coefficient is calculated for you automatically using regression analysis, you might want to experiment a bit by changing it and seeing the chart redraw dynamically. You can always reset it to the default value.
Disclaimer and credits
This article and ekwy.com website reference an opinion and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice.
You can always contact us at firstname.lastname@example.org