Ominous Signal Strikes for First Time in 90 Years

If one key indicator is to be trusted, the U.S. economy may be headed either for choppy waters or over a cliff, and the fallout for stocks may be enormous.

While there is no doubt that the forces of money supply creation and consequently inflation drive nominal prices higher over the long-term, the short-term is less easy to forecast with the same degree of accuracy.

Yet almost a century ago, the money supply did something strange right before the Great Depression, and the same thing appears to be happening today.

Should you be concerned?

Key Points

• M2 money supply has dropped nearly 4% over the past two years, an event not seen in almost a century.
• A shrinking money supply usually leads to reduced consumer spending, which makes up 70% of GDP, indicating potential economic trouble.
• Despite warnings, a recession isn’t confirmed but when it is, the S&P 500 usually falls thereafter.

What On Earth Is Going on With Money Supply?

The United States money supply is broken up into five components but the most prominent are M1 and M2. The former is a representation of what we most often think of as money, meaning dollar bills of all denominations and coins. M2 on the other hand represents savings accounts, CDs below $100k and money market accounts.

Remarkably, for the first time in almost 100 years, M2 has shrunk after steadily growing in each of the last nine decades consecutively. Over the past couple of years, M2 has fallen by just shy of 4%, which amounts to nearly $1 trillion. While it has been relatively steady over the past year or so, the decline from 2022 is noteworthy because it is so exceedingly rare.

Moreover, when it has occurred on each of the handful of times over the past 150 years, what followed was some form of economic treachery, generally a depression. That’s not a surprise because less money in circulation generally correlates with a net pullback in discretionary spending, and since the consumer is widely regarded as making up about 70% of GDP, the impact is meaningful.

Time to Sell?

Before racing to hit the Sell button, it’s important to be aware that recessions generally precede market pullbacks, and we have not yet entered a recession.

But with the market bumping up against all-time highs and last week’s action showing a rotation of institutional capital away from Big Tech and into small and mid-caps, it’s at least time to be wary of what corrections may be impending.

As Buffett has famously observed, timing the market short-term is exceedingly difficult so the best approach is often to simply follow a dollar-cost averaging plan where pullbacks are expected and used as opportunities to lower cost basis. Historically, this has worked out better for most than attempting to time the market top. Even for those that succeed, it’s often challenging to also time the bottom.

And if a bear market does occur, history has shown that bull markets last almost 4x longer, so the odds are it will be shorter and steeper than the long duration bull market we have been in.

As such, if you plan to bet on picking the top and bottom, you want to make sure you will be vigilant about watching the signs daily and weekly. Otherwise, the slow and steady path to riches that Buffett has favored, staying fully invested, has historically been the most lucrative one.