Market Commentary: Last Time This Happened Was 1933

If you have been keeping a close eye on markets and recent earnings reports, one figure that might cause you to scratch your head is Berkshire Hathaway’s enormous $157.1 billion cash pile. Why is Buffett holding so much cash?

One theory is that something ominous lies ahead for the economy and markets more generally. What could that possibly be? We discovered an indicator that last triggered in 1933 (and has done so again), which may suggest danger lies up ahead.

Key Points

• A rare economic indicator that last surfaced in 1933 has re-appeared, signaling potential peril. 
• The unusual decline in the M2 money supply, which has only occurred five times in the past century, is often a forerunner of deflation and a chilling prelude to significant economic contractions.
• Warning signs like Buffett’s cash hoard, the reduction in M2 money supply, and tighter lending practices by banks suggest that a broader economic slowdown may be on the horizon, with potential impacts on the market in late January 2024.

Here Comes Santa Claus

Gene Autry is famous for belting out the lyrics Here Comes Santa Claus, Here Comes Santa Claus, which aptly capture the sentiment of the next two months for the markets. This is the time of year when real structural flows support higher prices. We have discussed them in the past so we won’t delve into them in this particular article. The point is that the path of least resistance, though not guaranteed obviously, is higher for the stock market during the November to early January period.

It’s what comes thereafter that has many concerned. The breadcrumbs of worrisome facts are growing in number. One example is Buffett’s cash hoard. Another is the decline in M2 money supply. Of particular note is that only five dips have taken place in the past century, and each preceded a deflationary period in the US.

As an aside, if you’re new to the term M2, it factors in M1 (cash and coins in circulation) in addition to money market accounts, CDs under $100k, and savings accounts.

Typically these M1 and M2 figures grow over time as the economy expands, so they are often overlooked. But when they fall, it signals that perhaps all is not well under the hood of the economy, and that’s the case now.

What Happens After M2 Falls?

The concern over what follows an M2 decline is very real. Each and every time M2 has dipped in the past, a deflationary depression took place in addition to double-digit unemployment rates.

Some analysts have pointed to a further breadcrumb to signal a worrisome time lies ahead: commercial bank credit has fallen by over 2% after a period of expansion that lasted about half a century.

Clearly, financial titans are tightening their belts by raising lending standards. We have already seen that occur with mortgage lenders, which is one explanation as to why mortgage applications have fallen to 30-year lows.

It was announced recently that more than half of all banks have tightened their lending standards. Less money to loan out means fewer purchases, which means slower economic activity.

But it doesn’t all grind to a halt in a flash. The effects of higher interest rates and tighter lending standards makes its way through the system over time and eventually grows to become a flood that wipes out economic activity, which in turn hurts share prices.

The trillion dollar question is when will the market reflect the slowdown. For now, it seems the Santa Claus rally has legs, but beware what follows in late January 2024. Eagle-eyed investors will need to keep their pulse closely on markets then. A ride higher over the next 10 weeks may be equivalent to the slow march higher on a rollercoaster before the inevitable thrilling plunge.