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It is difficult to outperform stocks in terms of returns over a long period of time. When compared to gold, oil, housing, and government bonds, stocks outperform them all over the long term.
However, the predictability of directional movements is Dow Jones Industrial Average (^DJI 0.23%), S&P500 (^GSPC 0.80%)and Nasdaq Composite (^IXIC 1.14%) When the period narrows, it will be thrown out of the frame. Since the beginning of 2020, these three indexes have continuously oscillated between bear and bull markets.
Image source: Getty Images.
Predicting the direction of major indexes cannot be done with 100% accuracy, but that doesn’t stop investors from trying to get an edge. This is where highly selective economic data points and predictive indicators come in handy. Although Wall Street offers no short-term guarantees, some data points and indicators have a good track record of correlating with gains or losses in the broader market.
One data point that speaks volumes right now is the U.S. money supply.
The US money supply hasn’t done anything like this since 1933.
Of the five money supply indicators, two have received the most attention from economists and investors: M1 and M2. M1 takes into account all cash and coins in circulation and demand deposits in checking accounts. Think of M1 as cash that’s easy to obtain and can be spent in a blink of an eye.
M2, on the other hand, takes everything from M1 into account and adds savings accounts, money market accounts, and certificates of deposit (CDs) for amounts under $100,000. M2 is still pricing in cash available to consumers, but it’s adding capital, which will require a little more effort to access. It is this number, M2, that is ringing alarm bells in the investment world.
For more than a century, the U.S. money supply has been increasing almost uninterrupted. As an economy grows, more cash and coins need to be in circulation to complete transactions, so economists and investors tend to take increases in the money supply for granted and take them for granted. there is.
But on rare occasions, the U.S. money supply shrinks significantly, which historically portends bad news for the U.S. economy and stock market.
US M2 Money Supply Data by YCharts.
In July 2022, the US M2 money supply reached a record high of approximately $21.7 trillion. Based on data released by the Federal Reserve on February 27, M2 was $20.78 trillion as of January 2024. Overall, we see a total decrease of 1.44% compared to the previous year. This is down from the peak of 4.21% in July 2022. This is the first significant decline in M2 since the Great Depression.
What is important to note about the decline from July 2022 onwards is that M2 expanded at a truly historic pace during the COVID-19 pandemic. Due to fiscal stimulus, M2 increased by 26% year-on-year. Therefore, we can say that the 4.21% retracement is simply a regression to the mean. Again, the history of M2 money supply declining at least 2% on a year-over-year basis has been incredibly unforgiving.
According to research conducted by Reventure Consulting CEO Nick Ghaly based on data from the U.S. Census Bureau and the Federal Reserve System, backtesting back to 1870, there are only five instances where M2 decreased by at least 2%. , 1893, 1921, 1931-1933, and from July 2022 until at least January 2024. The previous four examples all coincided with deflationary recessions and double-digit unemployment rates.
Warning: Money Supply is officially in contract. 📉
This has only happened four times in the past 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
If there is any glimmer of hope, it is that two of the four past incidents predate the creation of the nation’s central bank, and the other two date back more than 90 years. Given the Fed’s knowledge of monetary policy and the fiscal tools available to the federal government, it seems highly unlikely that a depression would materialize today.
On the other hand, the decline in the money supply is not something that should be hidden. If core inflation exceeds the Fed’s long-term target of 2% and M2 continues to fall, disposable income will decline.
Based on data from american bank According to Global Research, about two-thirds of the S&P 500’s largest drawdowns occurred after the U.S. recession was declared, rather than before. In other words, a continued decline in M2 money supply could cause problems for the currently red-hot stock market.
Tracking money has been a problem for the past year.
The concern for investors is that M2 is just one money indicator that appears to be having a negative impact on the U.S. economy and stock prices overall. Another major money-based data point that is a cause for concern is commercial bank credit.
Commercial bank credit scores are reported weekly by the Federal Reserve Board and take into account all loans, leases, and securities held by U.S. commercial banks. Over the past 51 years, commercial bank credit has grown from approximately $567 billion to approximately $17.44 trillion as of the week ending February 14, 2024.
Just as M2 rises over time, it also makes perfect sense for commercial bank credit to expand periodically. As the U.S. economy grows, it’s natural for consumers and businesses to borrow more. Additionally, commercial banks offset their deposit-accepting costs with loans.
Problems arise when this steadily rising indicator heads decisively south.
Bank credit data for US commercial banks from YCharts.
Since data reporting began in January 1973, there have been only three instances in which commercial bank credit declined by at least 2 percentage points from its all-time high.
- In October 2001, during the height of the dot-com bubble, commercial bank credit fell by as much as 2.09%.
- In March 2010, immediately after the Great Recession, commercial bank credit bottomed out with a 6.94% decline.
- In November 2023, commercial bank credit reached a peak decline of 2.07%.
It is worth noting that commercial bank credit has started to rise in recent weeks, but the overall decline in 2023 is a pretty clear indication that banks are tightening their lending standards. When financial institutions become tougher on how they lend money, it’s not uncommon for companies to cut back on hiring, innovation, and acquisitions. In other words, a significant decline in commercial bank credit may be a harbinger of an economic downturn.
Although Wall Street and the economy are not tied together, recessions tend to have a negative impact on corporate earnings, resulting in expected declines in the Dow Jones, S&P 500, and Nasdaq Composite Index. By way of background, the S&P 500 lost about half its value during the last two major contractions in commercial bank credit.
Image source: Getty Images.
In fact, history is a long-term investor’s best friend.
Given that the Dow Jones Industrial Average and S&P 500 have soared to all-time highs in 2024, predicting a downside for the overall market is probably not what you want to hear. But just as history can sometimes serve as a short-term guide to downside stock prices, it can also often be a patient investor’s greatest ally.
Workers and investors may hate recessions, but the fact remains that they are a normal and inevitable part of the business cycle. They are also known for their short lifespans. After World War II, only three of the 12 recessions lasted 12 months, and none of the other three lasted more than 18 months. In other words, the US economic downturn is temporary.
Compare this to the past 78 years of growth. There were some growth spurts that lasted about a year, but most expansions were multi-year events. In fact, he has had two developmental periods that exceeded the 10-year mark.
This disparity between growth and contraction in the U.S. economy is visible in major Wall Street indicators. As an example, the S&P 500 has undergone double-digit percentage adjustments 40 times since its beginning in 1950. However, both of these declines were ultimately overtaken by a bull market rally. Although we can’t know exactly when these declines will occur, history shows fairly conclusively that the value of major indexes increases over time.
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
In addition to the above, Bespoke Investment Group analysts have created a dataset that compares the average duration of a bear market in the benchmark S&P 500 to a bull market since the beginning of the Great Depression in September 1929 in June 2023. It was announced on . The market lasted 1,011 calendar days, while the 27 bear markets over the past 94 years lasted an average of only 286 calendar days (about 9.5 months).
The ultimate data set, which overwhelmingly proves the power of time and perspective for investors, is updated annually by Crestmont Research.
Crestmont researchers analyzed the S&P 500’s 20-year total return, including dividends, going back to 1900. Although the S&P was created in 1923, researchers have been able to track the components of the S&P 500 with other major indexes. This allows us to backtest the total revenue data back to the early 20th century. This left Crestmont with 105 rolling 20-year periods (1919-2023) to analyze.
The Crestmont dataset showed that all 105 rolling 20-year periods produced positive total returns. Hypothetically speaking, as long as an investor bought his S&P 500-linked index since 1900 and held that position for his 20 years, they definitely made a profit. every time.
M2 No matter what the money supply or commercial bank credit suggests will happen to stocks, long-term investors stand perfectly positioned to succeed.
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