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

Over the previous four years, Wall Street has been a stomping ground for volatility. In successive years, beginning in 2020, the ageless Dow Jones Industrial Average (DJINDICES: ^DJI), broad-based S&P 500 (SNPINDEX: ^GSPC), and growth stock-driven Nasdaq Composite (NASDAQINDEX: ^IXIC) have traded off bear and bull markets.

Although the stock market has been a proven wealth creator over the long run, predicting where it’ll head in the days, weeks, or months to come simply can’t be done with any concrete accuracy. Nevertheless, it doesn’t stop investors from trying to forecast the future to gain an edge.

While nothing is set in stone over the short run, a select group of predictive indicators and money-based metrics have a remarkable track record of “forecasting” shifts in the U.S. economy and/or the stock market.

One of these tools, which appears to be a forewarning of a big move to come in stocks, is the U.S. money supply.

No one has witnessed the U.S. money supply do this in 90 years

Though there are five different measures of money supply, the two with the greatest importance are M1 and M2. The former takes into account all the cash and coins in circulation, as well as demand deposits in a checking account. It’s easily accessible capital that can be spent at the proverbial snap of a finger.

On the other hand, M2 utilizes everything in M1 and adds in money market accounts, savings accounts, and certificates of deposit (CDs) below $100,000. We’re still talking about capital that can be spent with relative ease, but some extra steps are required to get to it. It’s this metric, the M2 money supply, that is raising red flags for the U.S. economy and Wall Street.

What’s interesting about the M2 money supply garnering attention is that it’s a metric most economists tend to ignore. It’s been steadily rising for so many decades that it’s almost taken for granted that the money supply will expand as the U.S. economy grows over time.

But in those very rare instances throughout history where we’ve witnessed meaningful declines in M2 money supply, bad things have followed for the U.S. economy and stocks.

Based on data from the Board of Governors of the Federal Reserve, the M2 money supply peaked in April 2022 at $21.722 trillion. As of March 2024, M2 came in at $20.841 trillion. While this might look like a fairly tame decline of $881 billion (4.06%) spanning roughly two years, it represents the first decline of at least 2% in M2 money supply since the Great Depression.

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Let me add a bit of color and context to the data above. This aggregate drop of 4.06% comes after the U.S. money supply expanded by more than 26% on a year-over-year basis during the COVID-19 pandemic. Historically low interest rates and multiple rounds of fiscal stimulus injected capital directly into the U.S. economy. It’s possible that the decline we’re witnessing now is simply a reversion to the mean after a historic expansion of M2.

Furthermore, the M2 money supply has actually increased by 0.46% on a year-over-year basis after tumbling in 2023. The rising money supply is something we’d expect to see in a growing economy — more cash and coins are needed to complete an increasing number of transactions.

The caveat to the above is that history is (thus far) undefeated when the M2 money supply pulls back by at least 2% from its all-time high.

In March 2023, Reventure Consulting CEO Nick Gerli posted the chart you see above on X (the social media platform previously known as Twitter), which back-tested year-over-year changes in M2 money supply to 1870. Across this more than 150-year stretch, he found only five instances where M2 retraced by at least 2% on a year-over-year basis: 1878, 1893, 1921, 1931-1933, and 2023.

During the four previous instances of meaningful declines in M2, the U.S. economy fell into a depression with a corresponding unemployment rate that reached double digits.

To be fair, there was no central bank in 1878 or 1893. Further, the Fed and federal government have a much better understanding today than they did a century ago of how to fight back against economic downturns. This makes it highly unlikely that a depression with a double-digit unemployment rate would take shape.

But the data doesn’t lie — and history has, to this point, never been wrong. If less cash and coins are in circulation, consumers will be forced to reduce their discretionary spending. That’s bad news for the economy. If a recession were to take shape, as the decline in M2 would seem to imply, history suggests a sizable downdraft in stocks may follow.

Perspective is a powerful tool on Wall Street

The great thing about history is that it’s a two-sided coin. While there are clear headwinds that could put a serious dent in the current bull market for the Dow, S&P 500, and Nasdaq Composite, perspective paints a much brighter picture for long-term-minded investors.

Let’s address the elephant in the room: Recessions are a normal and inevitable part of the economic cycle. No matter how much we wish they’d go away and never return, downturns in the U.S. economy are going to occur from time to time.

However, recessions have historically been short-lived. Since the end of World War II, nine of the 12 U.S. recessions that took shape were resolved in under 12 months. Meanwhile, none of the remaining three made it past 18 months in duration. Though recessions can be unnerving, they resolve quickly.

On the other hand, most periods of growth that followed these one dozen recessions stuck around for multiple years. In fact, two periods of expansion extended beyond the 10-year mark. More often than not, corporate America is going to benefit from these lengthy expansions for the U.S. economy.

Patience and perspective have worked wonders for investors, as a data set from the analysts at Bespoke Investment Group has shown.

Researchers at Bespoke measured the length of every bear and bull market in the S&P 500 since the start of the Great Depression in September 1929. The 27 S&P 500 bear markets lasted an average of 286 calendar days, or about 9.5 months. By comparison, Bespoke found that the 27 S&P 500 bull markets endured for an average of 1,011 calendar days (as of June 2023), or approximately 3.5 times as long as the typical bear market.

What’s more, Bespoke’s data shows that 13 bull markets in the S&P 500 lasted longer than the lengthiest bear market. This reinforces the idea that while bear markets and recessions can be scary in the short run, optimism and long-term thinking are a winning recipe on Wall Street.

No matter what the M2 money supply or other predictive indicators suggest will happen in the coming weeks or months, history is crystal clear that the Dow Jones, S&P 500, and Nasdaq Composite are headed higher over the long run, along with the U.S. economy.

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Sean Williams has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

U.S. Money Supply Is Doing Something So Rare That It Hasn’t Happened Since the Great Depression — and a Big Move in Stocks May Follow was originally published by The Motley Fool