U.S. Money Supply Is Doing Something So Scarce That It Hasn’t Happened Since the Great Depression — and a Big Move in Stocks May Be Forthcoming

Wall Street has long proven itself to be an engine of wealth creation, and when compared to other asset classes such as gold, oil, homes and government bonds, stocks have overwhelmingly outperformed on an annualized return basis over the past century.

But when you narrow your focus to a few months or years, it becomes much harder to predict how the market as a whole will perform. Dow Jones Industrial Average (^DJI 1.51%)standard S&P 500 (^GSPC 0.80%)led by growth stocks Nasdaq Composite Index (^IXIC -0.01%) The first four years of this decade saw successive bear and bull markets.

When the stock market is volatile, it’s natural for investors to look for clues that indicate which direction stock prices will head next. While there are no predictive indicators or metrics that can specifically and accurately predict where the major stock indexes will head, that doesn’t stop investors from trying to get an edge.

but, teeth There are a few indexes that correlate strongly with the historical rise or fall of the Dow, S&P 500, and Nasdaq Composite Index.

One such forecasting tool, the first to issue such a warning since the Great Depression, appears to be foreshadowing a crisis in the U.S. economy and big moves in stock prices.

This is the largest increase in the U.S. money supply in more than 90 years.

The predictive measure mentioned above is the money supply in the U.S. There are five different measures of the U.S. money supply, but the two most valuable are M1 and M2.

The M1 money supply takes into account cash and coin in circulation, as well as current deposits in checking accounts. Think of this as money that is easily accessible and ready to spend. M2, on the other hand, adds everything in M1, plus savings accounts, money market accounts, and certificates of deposits (CDs) under $100,000. This is still accessible money, but it takes a bit more work to get hold of and spend. It is this category, the M2 money supply, that we should be concerned about.

Typically, little attention is paid to the M2 money supply, because it has been growing virtually uninterruptedly for the past 90 years. As the U.S. economy has grown over a long period of time, it is not surprising that more capital has been needed to facilitate transactions.

What is unusual is the decline in the US money supply, and that is exactly what we are currently witnessing with M2.

US M2 Money Supply data Y Chart.

In April 2022, the Federal Reserve reported that M2 had reached an all-time high of $21.722 trillion. This was up from $286.6 billion in January 1959, a compound annual growth rate of about 7%. However, as of April 2024, M2 was $20.867 trillion, a decline of about $855 billion (3.94% on a percentage basis) over two years. This is the first time since the Great Depression that the M2 money supply has fallen by more than 2% from its all-time high.

One important condition for this decline is that M2 rose sharply by 26% year-on-year during the peak of the COVID-19 pandemic. Multiple rounds of federal fiscal stimulus combined with low interest rates flooded the U.S. economy with capital, causing a rapid expansion of the money supply. One could argue that the nearly 4% decline in M2 over the past two years is simply a normalization after a historic expansion.

I’ll also point out that M2 is actually rising year-over-year: it’s down 3.94% from its all-time high in April 2022, but compared to a year ago, M2 is up just 0.14%.

However, history is pretty clear on what happens when the M2 money supply falls by at least 2% from its peak, and that is not good news for Wall Street or the U.S. economy.

As you can see from the above post by Nick Gerli, CEO of Reventure Consulting on social media platform X (formerly Twitter), it is very rare for M2 to fall by more than 2% year over year. Using data from the Federal Reserve and the U.S. Census Bureau, Gerli was able to backtest the percentage change in the U.S. money supply since 1870. During this period, there were only five instances when M2 fell by more than 2% year over year: 1878, 1893, 1921, 1931-1933, and 2023.

The last four times M2 has fallen by more than 2% have all correlated with US economic recession and double-digit unemployment.

The good news is that the Federal Reserve and the federal government are much more knowledgeable about how to deal with economic upheavals than they were a century ago. The Federal Reserve didn’t exist during the Great Depressions of 1878 and 1893, and was still finding its footing during the Great Depression of 1921. Very low The possibility of a sharp downturn in the U.S. economy in the modern era.

However, the decline in the U.S. M2 money supply suggests that the U.S. economy is likely to weaken in the not-too-distant future. With less capital in circulation, consumers are expected to cut back on discretionary spending, which often leads to an economic downturn.

Historically, the majority of declines in the S&P 500 have occurred after a U.S. recession has begun, not before.

Image source: Getty Images.

Statistically speaking, time is an investor’s greatest ally

With the Dow Jones Industrial Average, S&P 500, and Nasdaq Composite all on track to close at all-time highs in 2024, you probably don’t want your hopes ruined by predictions that stocks could fall substantially. Thankfully, this is a prediction that has little relevance to investors with a long-term mindset.

One of the most striking examples of time being a powerful ally can be seen in economic cycles.

While we may dislike the idea of ​​an economic contraction or recession, it is a normal and inevitable part of the boom-and-bust nature of the economic cycle. However, it is important to recognize that booms and recessions are not linear (i.e., they are not mirror images of each other).

[SincetheendofWorldWarIIinSeptember1945onlythreeofthe12USrecessionshavelasted12monthsbutnearlyalloftheeconomicexpansionshavelastedseveralyearsTwoperiodsofgrowthhavelasted10yearsRecessionscancausehigherunemploymentandslowerwagegrowthbuttheseeffectsareoftenshort-lived[1945年9月に第二次世界大戦が終結して以来、米国の景気後退は12回のうち3回しか12か月の期間を経なかったが、景気拡大期はほぼすべて数年にわたって続いた。成長期は2回、10年という期間に達した。景気後退は失業率の上昇や賃金上昇の鈍化を引き起こす可能性があるが、こうした影響は短期的であることが多い。

Similar nonlinear fluctuations are observed during bear and bull markets on Wall Street.

About a year ago, analysts at Bespoke Investment Group published a dataset on X that looked at the length of bear and bull markets in the S&P 500 going back to the start of the Great Depression. What Bespoke found was that over a 94-year period, the average bull market in the S&P 500 lasted roughly 3.5 times longer than a typical bear market: 1,011 calendar days (bull market) versus 286 calendar days (bear market).

Additionally, there have been 13 S&P 500 bull markets that lasted longer than the longest S&P 500 bear market since the start of the Great Depression.

Want more evidence that time is a losing ally for patient investors?

Earlier this year, Crestmont Research updated its data set for a report analyzing 20-year cumulative total returns, including dividends, for the S&P 500 going back to 1900. Although the S&P didn’t officially come into existence until 1923, its constituent stocks (and their cumulative returns) could be found in other major indexes prior to 1923, making it possible to track 20-year cumulative total returns going back to 1900.

Analysts at Crestmont Research found that all 105 20-year periods they looked at (from 1919 to 2023) had positive average annual returns. Simply put, if you bought an S&P 500 tracking index at any point since 1900 and held that position for 20 years, including dividends, you would have made money every time.

Regardless of what Wall Street has in store for investors over the next few months, patient investors have the luxury of time as an undefeated ally on their side.