It has been nothing short of a banner year for Wall Street. In October, the timeless Dow Jones Industrial Average(DJINDICES: ^DJI)benchmark S&P500(SNPINDEX: ^GSPC)and growth-driven Nasdaq Composite(NASDAQINDEX: ^IXIC) were celebrating their two-year anniversary of the current bull market. After the election of Donald Trump for a second (non-consecutive) term as president, all three stock indexes rose to record highs.
Despite these phenomenal returns, stock market corrections and bear markets are a normal and inevitable part of the investment cycle.
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While there is no predictive tool or forecasting metric that can predict short-term directional changes in Wall Street’s major stock indexes with concrete accuracy, there are a small number of events and data points that are highly correlated with significant moves up or down in the stock markets. Dow, S&P 500 and Nasdaq throughout history. Investors occasionally rely on these forecasting tools in an attempt to gain an edge.
While a number of valuation metrics are at or near all-time highs, which historically hasn’t been good news for Wall Street, the bigger concern might be an economic data point that has a flawless track record of signaling big drops in stocks . when it has been tested for over 150 years.
Image source: Getty Images.
Although typically an under-the-radar economic data point, the U.S. money supply has been causing a stir on Wall Street lately.
The two most commonly used measures of the US money supply are M1 and M2. The former accounts contain cash and coins in circulation, along with traveler’s checks and demand deposits from a checking account. The best way to think about M1 is cash that can be spent in an instant.
Meanwhile, M2’s money supply takes everything from M1 and adds money market accounts, savings accounts, and certificates of deposit (CDs) under $100,000. This is still money that consumers can access and spend, but it takes more effort to achieve. It’s also the specific measure of the money supply that worries Wall Street.
The reason M2 is typically an off-the-radar data point is because the U.S. money supply has been growing for nine decades without significant disruption. As the U.S. economy grows over time, it is no surprise that more capital is needed to facilitate transactions. A steadily increasing money supply indicates an economy on solid footing.
But on those exceptionally rare occasions in history when the M2 money supply has fallen significantly from all-time highs, it has portended major trouble for the US economy and stocks.
US M2 money supply data by YCharts.
Based on the latest monthly report from the Federal Reserve Board of Governors, the M2 money supply was $21.311 trillion in October 2024. This is down from a peak of $21.723 trillion in April 2022, representing a decline of 1.89%.
Even more remarkable, the M2 money supply fell by up to 4.74% between April 2022 and October 2023. This marked the first year-on-year decline in the M2 money supply of at least 2% since the depths of the Great Depression in 1933.
Of course, there are a few asterisks that go with the above statements. Firstly, this applies to the money supply of M2 climbed by 3.07% since the low point in October 2023. As previously noted, rising money supply is generally indicative of a healthy economy.
And the U.S. money supply skyrocketed during the pandemic. Fiscal stimulus measures pushed M2 up by more than 26% year-on-year. This means that the 4.74% decline between April 2022 and October 2023 may be nothing more than a return to the mean after a historic increase.
On the other hand, history has been very clear about what happens to the US economy and stocks when the M2 money supply declines significantly.
Although the data and chart you see above from Nick Gerli, CEO of Reventure Consulting, are dated (they were posted on social media platform are in the economy. The M2 money supply has been throughout history.
Looking back to the early 1870s, there have only been five instances in which M2 fell by 2% or more on an annual basis: 1878, 1893, 1921, 1931-1933, and 2023. The four previous instances are all related. with periods of depression for the US economy and double-digit unemployment. Although Wall Street and the U.S. economy are not tied together, economic contractions are almost always accompanied by stock market declines.
But there are also caveats to this data. For example, the Federal Reserve did not exist before December 1913. Moreover, the nation’s central bank and federal government are much more knowledgeable and have better tools today to combat significant downturns than was the case in 1921 or during World War II. Great depression. In other words, double-digit unemployment and a depression would be highly unlikely today.
Nevertheless, a meaningful decline in the M2 money supply suggests that consumers may be forced to scale back their discretionary purchases. This is often a key ingredient for the onset of an economic downturn.
Image source: Getty Images.
While history makes it very clear that stocks do not rise in a straight line, it is important that investors maintain perspective and recognize that history is a two-sided coin that undeniably favors those who are patient.
For example, although the central bank and federal government now have significantly more knowledge about preventing economic downturns than they did a century ago, recessions are still a normal and inevitable part of the economic cycle. No amount of good wishes can stop an eventual contraction.
However, history has shown that recessions disappear quickly. Since the end of World War II in September 1945, nine out of twelve recessions have resolved in less than a year, while the remaining three lasted no more than eighteen months. By comparison, the majority of economic expansions lasted many years, including two growth periods that exceeded the ten-year mark.
Even though recessions are a normal part of the economic cycle, history has shown that this cycle is not linear.
Bull and bear markets on Wall Street are also not linear.
The dataset you see above was released by researchers at Bespoke Investment Group in June 2023, shortly after it was confirmed that the S&P 500 was in a new bull market. Custom calculated and compared the calendar day length of every bear and bull market in the S&P 500, dating back to the start of the Great Depression in September 1929.
In total, the 27 bear markets that the S&P 500 has fought its way through over 94 years stuck around for an average of 286 calendar days, or about 9.5 months. On the other hand, the 27 bull markets in the S&P 500 lasted 1,011 calendar days, or only a little more than 3.5 times as long as bear markets.
Another thing to note is that, including the current bull market, 14 of the 27 bull markets in the S&P 500 since the Great Depression have lasted longer than the longest bear market (630 calendar days).
At any given time, there will likely be a forecasting tool or data point predicting trouble for Wall Street. But with the right patience and perspective, even the bleakest forecasts are not a cause for concern.
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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.
The US money supply has recently done something not seen since the Great Depression – and historically, this signals a big move in stock prices. originally published by The Motley Fool
