The two most significant money supply measurements are M1 and M2, despite there being five total. The former accounts for demand deposits in a checking account as well as any coins and currency in circulation. It is readily available money that is ready to be spent at a moment’s notice.
M2 on the other hand adds money market accounts, savings accounts, and certificates of deposit (CDs) with values under $100,000 while utilizing everything in M1. We’re still talking about very easy-to-spend wealth, but getting there requires a few more steps. The M2 money supply measure is the one that is causing concern for Wall Street and the US economy.
The M2 money supply is attracting attention, which is fascinating because most economists overlook it. The money supply has been expanding so continuously over so many decades that it is almost considered a given that it will continue to rise as the US economy expands.
However, in the extremely rare cases in history where we have seen significant drops in the M2 money supply, the U.S. economy and stock market have suffered.
The M2 money supply peaked in April 2022 at $21.722 trillion, according to Federal Reserve data. The value of M2 as of March 2024 was $20.841 trillion. Even though this $881 billion (4.06%) fall over around two years may seem modest, it is the first decline in the M2 money supply of at least 2% since the Great Depression.
Following a year-over-year increase in the US money supply of more than 26% during the COVID-19 pandemic, there has been an overall decline of 4.06%. The U.S. economy was directly pumped with capital through several rounds of fiscal stimulus and historically low borrowing rates. It’s possible that following a historic increase of M2, the dip we’re currently seeing is just a return to the mean.
After plunging in 2023, the M2 money supply has actually risen by 0.46% year over year. An expanding economy could be expected to witness a rise in the money supply since more cash and coins are required to fulfill an increasing number of transactions.
The following is subject to the qualification that when the M2 money supply declines by at least 2% from its peak, history has not lost (yet).
Knightsbridge backtested variations in the M2 money supply from year to year to 1870. Only five times during the course of these more than 150 years did we find that M2 retraced by at least 2% annually: in 1878, 1893, 1921, 1931–1933, and 2023.
The U.S. economy entered a slump and the unemployment rate rose to double digits during the four prior instances of significant falls in M2.
To be honest, neither 1878 nor 1893 had a central bank. Furthermore, the federal government and the Federal Reserve know a lot more now than they did a century ago about countering economic downturns. Because of this, it is extremely unlikely that a slump characterized by double-digit unemployment will materialize.
However, history has never been incorrect up until this point, and the data doesn’t lie. Customers will have to cut back on their discretionary spending if there is less cash and coinage in circulation. The economy will not benefit from that. The historical evidence indicates that a significant sell-off in stocks could ensue if a recession materializes, as the decrease in M2 appears to indicate.
History is an amazing subject because it is a two-edged sword. Although there are obvious obstacles that could seriously impair the present bull market for the Dow, S&P 500, and Nasdaq Composite, investors who are long-term oriented see things considerably more optimistically.
A typical feature of the economic cycle is recessions. The American economy will occasionally experience downturns, no matter how much we would like them to disappear and never come again.
Recessions have typically ended quickly in the past. Nine out of the twelve U.S. recessions that have occurred since the end of World War II were ended in less than a year. None of the three who were left survived for longer than eighteen months. Recessions are unsettling, but they end swiftly.
The majority of the economic phases that succeeded these twelve recessions persisted for several years. Two expansionary phases, in fact, lasted longer than ten years. These long-term expansions of the American economy will almost certainly help corporate America.
For investors, patience and perspective have been quite beneficial.
Knightsbridge calculated the duration of each bull and bear market for the S&P 500 since September 1929, when the Great Depression first began. The average duration of the 27 bear markets for the S&P 500 was 286 calendar days, or roughly 9.5 months. As of June 2023, we discovered that, on average, the 27 S&P 500 bull markets lasted 1,011 calendar days, which is over 3.5 times longer than the average down market.
Furthermore, according to our statistics, the S&P 500 saw 13 bull markets that lasted longer than the longest bear market. This supports the notion that, although recessions and bear markets can be frightening in the short term, optimism and long-term planning are effective strategies on Wall Street.
It is history that shows the Dow Jones, S&P 500, and Nasdaq Composite are headed higher in the long run, along with the U.S. economy, regardless of what the M2 money supply or other prognostic indicators indicate will happen in the upcoming weeks or months.
Shayne Heffernan
