U.S. Money Supply Did Something 2 Years Ago That Was Last Witnessed During the Great Depression -- and It Historically Foreshadows a Big Move in Stocks

Globe and Mail

02-03-2025

For more than two years, the bulls have been running wild on Wall Street. Since the curtain opened for 2023, the iconic Dow Jones Industrial Average (DJINDICES: ^DJI), broad-based S&P 500 (SNPINDEX: ^GSPC), and growth stock-dependent Nasdaq Composite (NASDAQINDEX: ^IXIC) have respectively risen by 31%, 55%, and 82%, with all three indexes notching multiple record-closing highs.
But while the stock market has been an undisputed long-term wealth creator, history shows that it doesn't move up in a straight line. Investors are constantly looking for data points and metrics that can forecast short-term directional shifts in the Dow Jones, S&P 500, and Nasdaq Composite.
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Even though there's no such thing as the perfect data point that can concretely predict short-term moves in the stock market, there are a small number of events, data points, and predictive indicators that have strongly correlated with big moves higher or lower in Wall Street's major stock indexes. It's these highly correlative data points that typically garner the most attention and raise investors' eyebrows.
Although the stock market's historically pricey valuation and President Donald Trump's tariffs are the talk of Wall Street at the moment, perhaps the biggest concern ties to an economic data point that recently made history for the first time in 90 years.
U.S. money supply hadn't done this since 1933
Among the laundry list of economic data points released monthly, the one that recently made history is U.S. money supply.
While money supply has five different measures, the most followed are M1 and M2. The former takes into account cash and coins in circulation, demand deposits in a checking account, and traveler's checks, which now make up a small percentage of global spending. The best way to think about M1 is as cash that can be spent at a moment's notice.
Meanwhile, M2 is comprised of everything from M1 and adds in money market accounts, savings accounts, and certificates of deposit (CDs) below $100,000. It's still money that consumers can spend, but it often requires a bit more effort to get to. It's this measure, M2, that made history for the first time since 1933.
For much of the last nine decades, M2 money supply has risen with nothing more than tiny blips lower (fractional declines of 0.1% to 1.5% from the all-time high). Growing economies need more capital to facilitate transactions, which explains why M2 has moved higher so consistently since the mid-1930s.
But in those exceedingly rare instances where M2 moves notably lower, it's resulted in a rude awakening for the U.S. economy and stock market.
US M2 Money Supply data by YCharts.
As of January 2025, the Board of Governors of the Federal Reserve System reported M2 money supply of $21.561 trillion, which is $162 billion below the all-time high of $21.723 trillion that was achieved in April 2022. In aggregate, this represents a relatively modest drop-off of 0.74%, as you can see in the chart above.
However, between April 2022 and October 2023, M2 money supply declined by a peak of 4.74%. This marked the first year-over-year drop of at least 2% since the Great Depression, as well as the steepest peak-to-trough decline in 90 years.
To add a bit more color to the chart above, you'll note that M2 has meaningfully bounced from its October 2023 low and is climbing on a year-over-year basis, once again. Growing money supply is usually indicative of a healthy economy.
What's more, M2 money supply expanded by an all-time record of 26% on a year-over-year basis during the height of the COVID-19 pandemic. It's possible the historic decline two years ago represents nothing more than a reversion to the mean as the U.S. economy absorbed a roughly $6.2 trillion increase in M2 money supply in just over two years.
But the prevailing concern is there's more to this move than just a simple reversion to the mean.
WARNING: the Money Supply is officially contracting. 📉
This has only happened 4 previous times in last 150 years.
Each time a Depression with double-digit unemployment rates followed. 😬 pic.twitter.com/j3FE532oac
-- Nick Gerli (@nickgerli1) March 8, 2023
The post you see above from Reventure Consulting CEO Nick Gerli on social media platform X is effectively two years old. I'm presenting it as a historic reminder of how the U.S. economy and stock market have previously reacted when M2 money supply has declined by at least 2% on a year-over-year basis.
Including what occurred in 2023, there have been five instances in 155 years where M2 has fallen by at least 2% year over year: 1878, 1893, 1921, 1931-1933, and 2023. The four prior occurrences correlate with periods of economic depression and double-digit unemployment for the U.S. economy.
If there's a silver lining here, it's that the Federal Reserve didn't exist in 1878 or 1893, and both the Fed and federal government have more knowledge and better respective monetary and fiscal policy tools they can lean on in modern times to avoid a depression and double-digit unemployment.
Nevertheless, the first sizable drop-off in M2 since the Great Depression signals the potential for a recession to take shape. When the U.S. economy weakens or shifts into reverse, it eventually drags on corporate earnings. It's this cement weight that can pull stocks notably lower.
Now for the good news...
While the prospect of a sizable decline in the Dow Jones Industrial Average, S&P 500, and Nasdaq Composite might not be what investors want to hear, there's good news, too. Namely, historic precedent is a pendulum that swings in both directions and undeniably favors investors who look to the horizon.
There's arguably not a data set that demonstrates the value of time in the market, rather than trying to time the market, better than Crestmont Research's examination of S&P 500 total returns over time.
Every year, the analysts at Crestmont calculate the rolling 20-year total returns, including dividends, of the benchmark S&P 500. Crestmont has back-tested these rolling 20-year periods to 1900, which resulted in 106 ending years (1900 to 1919, 1901 to 1920, and so on, through 2005 to 2024).
What Crestmont Research found with its analysis is that all 106 rolling 20-year periods produced a positive annualized total return. In simple English, if an investor had, hypothetically, purchased an index fund that mirrored the performance of the S&P 500 at any point between 1900 and 2005 and held their position for 20 years, they'd have made money every time. Time in the market has always proved more valuable than trying to time when corrections will occur.
A separate study from Bespoke Investment Group adds even more color to the power of long-term investing.
It's official. A new bull market is confirmed.
The S&P 500 is now up 20% from its 10/12/22 closing low. The prior bear market saw the index fall 25.4% over 282 days.
Read more at https://t.co/H4p1RcpfIn. pic.twitter.com/tnRz1wdonp
-- Bespoke (@bespokeinvest) June 8, 2023
In a social media post on X, shortly after the S&P 500 was declared to be in a new bull market in June 2023, Bespoke's analysts published the data set above, which compares the length of every bull and bear market dating back to the start of the Great Depression in September 1929.
On one end of the spectrum, the average bear market has endured for only 286 calendar days (about 9.5 months), and the longest bear market on record stuck around for 630 calendar days. On the other hand, the typical S&P 500 bull market clocks in at 1,011 calendar days -- roughly 3.5 times longer than the average bear market -- and around half of all bull markets have lasted longer than the lengthiest bear market.
What Bespoke's and Crestmont's data sets conclusively show is that time and perspective are far more powerful tools for investors than any event, data point, or short-term correlative indicator will ever be.
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