The U.S. money supply hasn’t been like this since the Great Depression, which usually signals big moves in the stock market.

For decades, Wall Street has reliably created wealth. When compared to the annual returns of housing, gold, oil, and even bonds, the stock market can easily outperform these asset classes over the long term.

But things get a little choppy when narrowing the horizon and investors look at broader market performance over years or months.Timeless since the beginning of this decade Dow Jones Industrial Average (^DJI 0.07%)standard S&P500 (^GSPC 0.18%)and growth-driven Nasdaq Composite (^IXIC 0.09%) Every year, we have alternated between bear markets and bull markets. This volatility has investors wondering what the stock market will do next.

Image source: Getty Images.

There is no reliable predictor or indicator that can predict the direction of the Dow Jones, S&P 500, or Nasdaq Composite Index with 100% accuracy. However, there is a select group of data points that have a very accurate track record of correlating with large movements in stock prices.

One indicator that Wall Street and investors should be paying close attention to right now is the U.S. money supply.

The US money supply hasn’t done anything like this since 1933.

There are several measures of money supply, but the two that economists tend to focus on the most are M1 and M2.

M1 Money supply includes cash and coins in circulation and demand deposits in checking accounts. Think of M1 as instant, easy-to-spend money. M2 takes everything from M1 and adds savings accounts, money market accounts, and certificates of deposit (CDs) for amounts under $100,000. It’s money that people still have relatively easy access to, but it takes a little more effort to spend. It is this latter category that has raised eyebrows and set off alarm bells.

Historically, M2 has increased at a relatively steady pace for over 150 years. As the U.S. economy grows, more capital is needed to facilitate trade. However, in rare cases where M2 drops significantly, a problem arises.

US M2 Money Supply Data by YCharts.

As you can see from the graph above, M2 money supply has declined from a peak of $21.7 trillion in July 2022 to $20.77 trillion in November 2023. M2 decreased by just over 2% on a year-over-year basis and by 4.31% year-over-year. The all-time high will be recorded in mid-2022. This is the first significant decline in the M2 money supply since the Great Depression.

Although this is a very modest decrease in percentage terms, very big transaction For an economy plagued by scorching inflation rates. More capital will be needed to pay for goods, as prices for goods and services overall are rising faster than the Fed’s long-term goal of 2%. But if M2 is shrinking, it means people and businesses have to refrain from making certain purchases. That’s typically a recipe for recession.

In the past, when M2 decreased significantly, the US economy did not fare well. Although there have been several times when M2 has slightly decreased in backtesting up to 1870, there have only been 5 times in the past 154 years where M2 has decreased by more than 2% year over year. In 1921, the fifth trial was ongoing from 1931 to 1933. All four previous cases resulted in deflationary recessions in the U.S. economy and large increases in unemployment.

Warning: Money Supply is officially in contract. 📉

This has only happened four times in the last 150 years.

Each time was followed by a Great Depression with double-digit unemployment rates. 😬 pic.twitter.com/j3FE532oac

— Nick Gurli (@nickgerli1) March 8, 2023

To be fair, things have changed pretty Relations with the U.S. economy in the late 19th and early 20th centuries. The Federal Reserve did not exist during the Panic of 1878 or the Panic of 1893. The Federal Reserve has a wealth of knowledge about how to best deal with economic recessions compared to the Panic of 1921 and the Great Depression. The likelihood of a Great Depression occurring today is much lower than it was 100 years ago.

At the same time, a decline in M2 has historically been a precursor to a recession. Since the Great Depression began in September 1929, about two-thirds of the S&P 500’s drawdowns have occurred after, rather than before, a recession was declared. In other words, if the U.S. economy turns around, we can expect a pullback or potential bear market in stock prices.

M2 is not the only value-based metric to raise alarms.

As much as we would like to say that M2 money supply is the only money-based indicator that is currently alarming Wall Street, that is not the case. Commercial bank credit is another potentially concerning money-focused data point.

M2 Like the money supply, commercial bank credit, which includes all loans, leases, and securities held by U.S. commercial banks, has been trending upward in recent decades with a few exceptions. Since data reporting began in January 1973, commercial bank credit has increased from $567 billion to $17.36 trillion as of the week ending December 20, 2023. This corresponds to an average annual growth rate of approximately 7% over half a century.

This increase is not surprising. As the U.S. economy expands, banks tend to expand their loan and lease portfolios over time. However, if this steady upward trend in commercial bank credit is interrupted, investors should exercise extreme caution.

Bank credit data for US commercial banks from YCharts.

As shown in the graph above, there have been dozens of instances over the past 50 years in which commercial bank credit has endured small (less than 1.5%) declines. However, commercial bank credit has only fallen by more than 2% from its all-time high three times in 51 years.

• At the height of the dot-com bubble in October 2001, the decline peaked at 2.09%.
• After the Great Recession in March 2010, it fell an astonishing 6.94%.
• As of November 2023, the maximum rate of decline (so far) is 2.07%.

The recent decline in commercial bank credit shows that financial institutions are tightening lending standards, limiting some companies’ access to capital. This is like pressing the brakes on a car moving at high speed, and is expected to slow corporate earnings growth or even reverse it.

The two previous instances in which commercial bank credit declined by at least 2% coincided with the benchmark S&P 500 index losing about half of its value.

Image source: Getty Images.

History is a two-sided coin that strongly favors patientness and optimism.

Key money-based metrics are telling us so far that 2024 could be a tough year for investors. But investing is all about perspective, and history is two sides of the same coin, greatly favoring those with an optimistic long-term approach.

We may not like recessions, but they are normal and expected in business cycles. Since the end of World War II in September 1945, there have been 12 recessions in the United States. Nine of these 12 cases lasted only a month, while the remaining three he did not last more than 18 months. Conversely, her two expansions after World War II lasted at least a full decade.

This unevenness between economic expansion and contraction can also be seen in the stock market.

It’s official. A new bull market has been confirmed.

The S&P 500 is currently up 20% from its October 12, 2022 closing low. During the last bear market, the index fell 25.4% in 282 days.

For more information, please visit https://t.co/H4p1RcpfIn. pic.twitter.com/tnRz1wdonp

— Bespoke (@bespokeinvest) June 8, 2023

Last year, researchers at Bespoke Investment Group released a dataset examining the average duration of S&P 500 bull and bear markets since the start of the Great Depression. As shown in the post above, a typical bear market lasts just 286 calendar days, or 9.5 months. On the other hand, the average bull market lasts 3.5 times longer (1,011 calendar days).

Additionally, there have been 13 bull markets in the S&P 500 over the past 94 years, lasting longer than the longest bear market. If that’s not a fervent embrace of Wall Street optimism, I don’t know what is.

Perhaps the greatest example of using time as an ally comes from an annually updated dataset published by Crestmont Research. Crestmont analysts looked at his 20-year total return for the S&P 500, including dividends paid, going back to 1900. Although the S&P has been around since 1923, its components were found in other major indexes before the creation of the S&P 500. This allowed researchers to accurately backtest his total return to 1900.

Of the 104 20-year periods examined by Crestmont Research (1919-2022), 100% produced positive total returns. In other words, it doesn’t matter when an investor puts money into his S&P 500-linked fund, as long as he (if) holds the position for his 20 years. Regardless of what 2024 has in store for Wall Street, time is an investor’s greatest ally.