It's been 90 years since M2 money supply has contracted by at least 2%.
Who needs a theme park when you have Wall Street. Over the trailing two years, we've watched the ageless Dow Jones Industrial Average (^DJI 0.84%), widely followed S&P 500 (^GSPC 1.23%), and growth-dominated Nasdaq Composite (^IXIC 1.45%), roar to new all-time highs, plunge into a bear market, and regain their luster, once more. This short-term roller-coaster ride has new and tenured investors alike wondering what's next for Wall Street.Although it's not an economic datapoint most investors would think of turning to for guidance, U.S. money supply may hold the answer as to what's next for stocks.
M2 money supply hasn't done this since the Great Depression
Though there are a few variations of money supply, most economists tend to focus on M1 and M2. The former takes into account cash and coins in circulation, as well as demand deposits in checking accounts and traveler's checks. In other words, money that's either in your hand or can be accessed very easily.Meanwhile, M2 accounts for everything in M1 and adds savings accounts, money market funds, and certificates of deposit (CDs) below $100,000. It's money you have access to, but it takes a little extra effort to put this capital to work. It's M2 money supply that's raising eyebrows on Wall Street and making history.
During the COVID-19 pandemic, M2 soared by 26% on a year-over-year basis, which represents the steepest increase in U.S. money supply when back-tested to 1870. The issuance of multiple rounds of stimulus checks to the American public, along with pandemic-based programs for businesses, pumped capital into the U.S. economy at an extraordinary pace. Unsurprisingly, historically high inflation -- 9.1% at the peak in June 2022 -- soon followed.
What's of interest is what's happened to M2 money supply over the trailing year. Following a peak of $21.7 trillion in July 2022, M2 has fallen to a fresh reading of $20.81 trillion, as of May 2023. Although the May reading was higher than April and broke a nine-month downtrend, we've still witnessed a 4.1% aggregate drop in M2 from its all-time high.
Considering that M2 enjoyed a historic expansion during the pandemic, it's certainly possible that a 4.1% decline can be shrugged off as nothing more than money supply reverting back to the mean. But history suggests otherwise.
Though history rarely repeats itself on Wall Street, it often rhymes. We haven't seen a meaningful year-over-year decline in M2 money supply since the Great Depression in 1933.
Thanks to a dataset supplied by Reventure Consulting CEO Nick Gerli, we also know that the only four times since 1870 where M2 contracted by at least 2% resulted in deflationary recessions for the U.S. economy. To be completely fair, these occurrences were in the 1870s, 1893, 1921, and the Great Depression. Two of these instances were prior to the formation of the Federal Reserve, and the understanding the nation's central bank has of monetary policy has vastly evolved over the past century. Chances are that a steep depression wouldn't occur in present-day America.
Nevertheless, declining money supply with an above-average inflation rate isn't an ideal combination. If fewer dollars and coins are available to purchase goods and services, the expected response is for consumers and businesses to not buy as much. Historically speaking, that's a recipe for a recession -- and recessions can lead to sizable downside in the Dow Jones, S&P 500, and Nasdaq Composite.
U.S. Money Supply Is Doing Something Not Seen Since the Great Depression, and It May Signal a Big Move to Come for Stocks | The Motley Fool
It's been 90 years since M2 money supply has contracted by at least 2%.
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