Recently, the U.S. money supply exhibited an occurrence not seen since the Great Depression, which historically is indicative of a substantial shift in stock market trends.
In a remarkable year for Wall Street, the Dow Jones Industrial Average (DJI), S&P 500, and Nasdaq Composite celebrated their two-year anniversary of this ongoing bull market, reaching record-breaking highs following the election of a second term for President Donald Trump. Despite these impressive returns, it's essential to remember that corrections and bear markets are an inevitable part of the investing cycle.
While no prediction tool can accurately forecast short-term changes in Wall Street's major indexes, certain events and data points have historically correlated with substantial moves in the Dow, S&P 500, and Nasdaq. Investors occasionally utilize these indicators in the hopes of gaining an edge.
Two valuation metrics nearing all-time highs are causing some concern, but there's a more pressing issue that has an almost perfect track record of signaling significant drops in stocks when analyzed over an extended period.
M2 Money Supply Dropping Like Never Before
Although it's usually a forgotten economic data point, U.S. money supply is making headlines on Wall Street. The two main measures of money supply are M1 and M2. M1 incorporates cash and coins in circulation, along with travelers' checks and checking account deposits. M2, the more relevant factor influencing stocks, adds money market accounts, savings accounts, and certificates of deposit below $100,000.
M2 money supply had a steady growth pattern for 90 years, but a remarkable decline from its all-time high was observed. In October 2024, M2 totaled $21.311 trillion, down from April 2022's peak of $21.723 trillion – a drop of 1.89%. The decline was even more notable, reaching 4.74%, from April 2022 to October 2023, marking the first year-over-year decline of at least 2% in M2 money supply since the Great Depression in 1933.
However, it's essential to remember two caveats. First, M2 money supply climbed by 3.07% since hitting its low in October 2023. Second, the outstanding increase in U.S. money supply, fueled by fiscal stimulus, may have simply resulted in a mean reversion to normal levels after the historic rise during the pandemic.
Regardless, history has shown that a substantial decrease in M2 money supply often precedes significant problems for the U.S. economy and stocks.
History's Ups and Downs
It's critical for investors to stay patient and recognize that history, while often visible in nonlinear patterns, generally favors those who wait. As an example, despite advancements in the central bank and government's tools to prevent economic downturns, recessions still occur. However, these recessions tend to be short-lived, with nine out of twelve ending within a year. Conversely, economic expansions usually last longer, often surpassing the decade mark.
Similarly, bull and bear markets on Wall Street aren't linear. Although the average bear market lasts approximately 9.5 months, bull markets typically persist much longer, with an average length of about 3.5 times that of bear markets. It's not uncommon for bull markets to outlast the longest bear markets.
In conclusion, a significant drop in money supply may suggest that consumers may scale back on their discretionary purchases, which is often a leading factor in economic contractions. Investors should remain patient and maintain a long-term perspective, recognizing that history consistently favors those who don't panic and maintain their focus.
In light of the M2 money supply dropping significantly, some investors might be reconsidering their investment strategies. This decrease in money supply could potentially lead to consumers reducing their discretionary spending, potentially affecting the economy and the stock market.
Given the historical pattern, it's important for investors to stay patient during economic contractions, as they tend to be short-lived, often ending within a year. Recognizing the cyclical nature of bull and bear markets, investors should focus on maintaining a long-term perspective, avoiding panicking during market fluctuations.
