Global equities and bank reserves held at the Fed, Bank of Japan (BOJ) and ECB have trended higher since the 2008-09 crisis / recession – see first chart. This has prompted claims that central bank liquidity creation has been the key driver of markets.

The view here is that the twin upward trends are largely coincidental. There was no correlation between equities and reserves before the crisis. Liquidity availability for markets depends on the relative growth rates of the real (inflation-adjusted) money stock and output. Global real narrow money has mostly risen faster than industrial output since 2008, explaining equity gains. The relative strength of real money growth, of course, partly reflects central bank policies but is only loosely related to rising reserves.

The largest fall in equities since 2009 occurred in 2011: the MSCI All-Country World Index in US dollars suffered a 23.9% peak-to-trough decline over May-October. This followed a period in 2010 when annual growth of G7 real narrow money was beneath that of industrial output – second chart. By contrast, G3 bank reserves were rising strongly before the 2011 correction.

The G7 real money / output growth gap remains significantly positive and is unlikely to close before end-2015. G3 reserves, meanwhile, will continue to trend higher as the BOJ and ECB proceed with QE programmes – third chart. Both indicators, therefore, suggest further near-term upside for equities but “excess” money growth is more likely to warn of the next bout of weakness.