For the second year in a row, Wall Street gave investors plenty to smile about. When the curtain comes down in 2024, forever Dow Jones Industrial Average(DJINDICES: ^DJI)broad based S&P 500(SNPINDEX: ^GSPC)and inspired by innovation Nasdaq Composite(NASDAQINDEX: ^IXIC) they grew by 13%, 23%, and 29% respectively during the year and along the way reached several record highs.
But as history has shown, Wall Street’s major stock indexes do not rise evenly.
Investors are constantly on the lookout for forecasting tools and data points that could signal a shift in the Dow Jones, S&P 500 and Nasdaq Composite and give them a competitive edge. While there is no such tool or metric that is 100% accurate in predicting the short-term directional movements of major stock indices, there are a small number of data points and events that strongly correlated with moves up or down in the Dow, S&P 500 and Nasdaq Composite over time.
Although a strong argument can be made that a historically expensive stock market is the biggest concern for investors, the first move in another monthly economic data point in 90 years could take the cake.
Image source: Getty Images.
The correlative data in question that should raise eyebrows on Wall Street is the US money supply.
Although there are five different measures of the money supply, the two that usually get the most attention are M1 and M2. The first takes into account cash and coins in circulation, demand deposits in a checking account and traveller’s cheques. M1 is essentially money that consumers can spend on the spot.
Meanwhile, M2 takes everything within M1 into account and adds money market accounts, savings accounts, and certificates of deposit (CDs) under $100,000. That’s still money for consumers to spend, but it takes more effort to get there. It is also a specific measure of the money supply that is causing concern on Wall Street.
Usually the M2 chart slopes up and to the right. This means that as the US economy has grown over time, the money supply has also increased, reflecting the need for more cash in circulation to facilitate transactions. But in those extremely rare instances throughout history when M2 suffered significant declines, it spelled trouble for the US economy and the stock market.
Based on data reported monthly by the Board of Governors of the Federal Reserve System, M2 was $21.448 trillion in November 2024, down from an all-time peak of $21.723 trillion in April 2022. This represents a modest decline of 1.26% from the peak. of all time.
But between April 2022 and October 2023, the M2 money supply shrank by a peak of $1.06 trillion, or 4.74%. This is the first time since the Great Depression that M2 has fallen by more than 2% annually.
However, this historic descent into the M2 tells only part of the story. For example, fiscal stimulus during the height of the COVID-19 pandemic caused M2 to increase by more than 26% year-on-year. The 4.74% decline recorded between April 2022 and October 2023 could be just a form of mean reversion after the fastest expansion of the money supply in more than 150 years.
Furthermore, M2 has reversed course since October 2023 and is now rising year-on-year. As noted, an increase in the money supply usually accompanies a healthy economy.
Despite this, significant year-over-year declines in M2 have an impeccable record of foreshadowing trouble for the economy.
The chart you see above, posted in March 2023 by Reventure Consulting CEO Nick Gerli on social media platform X, examines the correlation between a decline in M2 of at least 2% year-over-year and the performance of the US economy from before 1870.
Over the past 155 years, there have been only five times when M2 fell by at least 2% on an annual basis: 1878, 1893, 1921, 1931-1933. and 2023. Here’s the kicker: all four previous examples correlate with economic depressions and double-digit unemployment rates for the US economy.
The asterisk on this correlative data is that the tools of fiscal and monetary policy available today are vastly different from what could have been done in the late 1800s or early 1900s. For example, the Federal Reserve didn’t even exist in 1878 or 1893. Meanwhile, the knowledge the central bank now has makes depression unlikely in the modern age.
Despite this star, there are concerns that falling M2 amid a period of above-average inflation will lead consumers to delay discretionary purchases. This can lead to an economic crisis that eventually weighs on the company’s earnings.
According to the analysis from Bank of America According to the Global Survey from 1927 to March 2023, about two-thirds of the decline in the S&P 500 occurred after, rather than before, a recession was declared.
Image source: Getty Images.
Based solely on what history tells us, the new year could bring volatility and a significant correction in the Dow Jones Industrial Average, S&P 500 and Nasdaq Composite. But the thing to understand about history is that the outlook for stocks can change dramatically depending on your investment horizon.
For example, analysts at Crestmont Research have been updating a dataset for years that examines trailing 20-year total returns, including dividends, benchmarks S&P 500 since the beginning of the 20th century. Although the S&P didn’t officially exist until 1923, Crestmont was able to locate its components in other indexes to test total return data back to 1900. This produced 105 rolling 20-year periods, with end dates from 1919 to 2023.
What Crestmont found is that, including dividends, the S&P 500 has generated a positive total return in 105 of the 105 rolling 20-year timeframes. If an investor had, hypothetically, bought the S&P 500 tracking index at any time from 1900 to 2004 and simply held that position for 20 years, they would have made money every time.
A dataset released on X in June 2023 by Bespoke Investment Group provides even more compelling evidence of how important patience and perspective are on Wall Street.
As you can see in the table above, researchers at Bespoke have calculated the calendar day length of every bear and bull market in the S&P 500 since the start of the Great Depression in September 1929.
According to Bespoke’s calculations, the S&P 500’s 27 bear markets over 94 years lasted an average of just 286 calendar days, or 9.5 months. Furthermore, the longest bear market on record, which occurred in the mid-1970s, lasted only 630 calendar days.
On the other side of the aisle, a typical S&P 500 bull market since the late 1920s has lasted 1,011 calendar days, or roughly two years and nine months. Additionally, more than half (14 of 27) of all bull markets, including the current bull market if extrapolated to date, lasted longer than the S&P 500’s longest bear market.
No matter how scary short-term economic data can be, history is undeniably favorable to long-term investors.
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Bank of America is an advertising partner of Motley Fool Money. Sean Williams holds positions at Bank of America. The Motley Fool has positions in and recommends Bank of America. The Motley Fool has a disclosure policy.
