For nearly two years, the stock market has experienced a remarkable surge, with major indices such as the Dow Jones Industrial Average, the S&P 500, and the tech-heavy Nasdaq Composite reaching historic highs in 2024. However, investors are acutely aware that financial markets rarely move in a straight line, and history illustrates that corrections are a natural aspect of market behavior.
One predictive tool that has historically shown a strong correlation with significant market movements is the U.S. money supply. This key economic indicator has demonstrated its relevance over the past century and more, with a remarkable track record of signaling major shifts in the equity landscape.
When looking at the various measures of money supply, M1 and M2 stand out. M1 consists of cash, coins, and checking account deposits, reflecting the most liquid forms of money in circulation. Conversely, M2 includes all of M1 plus savings accounts, money market accounts, and certain types of certificates of deposit—essentially capturing a broader view of available capital for economic activity.
Historically, the M2 money supply has exhibited a consistent upward trend, a reflection of general economic growth. Yet, there have been rare instances in the last 150 years where substantial declines in M2 have preceded significant economic downturns. The most recent scenario occurred in 2023, with a year-over-year decline reminiscent of the early stages of past depressions.
As we approached the end of summer 2024, M2 amounted to approximately $21.175 trillion, marking a decrease of 2.52% from its peak. This downturn was noteworthy as it marked the first year-over-year reduction of at least 2% since the Great Depression. Interestingly, the M2 money supply has begun to rise again, which, given the historical context, may indicate the economy’s potential recovery from a turbulent period.
The worrying aspect remains that significant declines in M2 historically correlate with increases in retail prices and reductions in consumer discretionary spending, setting the stage for potential recessions. With research from Bank of America Global Research suggesting that two-thirds of S&P 500 drawdowns occur after recessions have already begun, the current trends in money supply could foreshadow downward pressure on equities.
When considering historical recessions, the frequency of downturns since World War II is notable. On average, the U.S. experiences a recession every 6.6 years, but the speed of recovery post-recession often provides a silver lining. While the average recession lasts about 11 months, periods of economic expansion are considerably longer, often spanning several years.
For those with a long-term investment perspective, history supports the idea that remaining optimistic leads to better outcomes. The recent confirmation of a bull market, with significant recoveries from previous lows, further emphasizes the resilience of the stock market and underscores the importance of maintaining a balanced view of market cycles.
While there are no definitive answers about when market corrections will happen or how deep they may go, investors are encouraged to stay informed and adaptable. The historical relationships between money supply trends, economic conditions, and market behavior remind us that patience and strategic planning often yield the best results in the world of investing.
As we move forward, consider exploring robust investment options and stay engaged with market developments. Stock tips from seasoned analysts may offer valuable insights as you navigate this ever-changing landscape. Aligning investment strategies with historical perspectives can create a path for success as you respond to economic shifts.
By understanding the implications of money supply changes and preparing for potential market fluctuations, you can position yourself advantageously in the dynamic world of finance.