U.S. Money Supply's Historic Move: A Harbinger of Stock Market's Next Big Move?

Two years ago, the U.S. money supply, specifically M2, experienced a significant decline, reaching unprecedented negative rates of growth. This shift in money supply has historical parallels to the Great Depression and could potentially foreshadow a significant move in the stock market. This article explores the relationship between money supply and stock market performance, drawing insights from historical data and monetary policy decisions.

Money Supply and Stock Market Performance: A Historical Perspective

Historical data suggests a strong relationship between money supply and stock market performance. A study by Sirucek (2012) found that the Dow Jones Industrial Average (DJIA) and two money supply aggregates, M2 and MZM, were cointegrated, indicating a long-term equilibrium relationship between them. Additionally, the study found evidence of Granger causality between the money supply aggregates and the DJIA, suggesting that changes in money supply influence stock market performance.

Monetary Policy Decisions: Shaping the Relationship

Monetary policy decisions play a significant role in shaping the relationship between money supply and stock market performance. In 2021, the Federal Reserve announced it would begin tapering its asset purchases, which eventually led to a decline in M2 growth. This reduction in M2 growth may have contributed to the negative year-over-year growth rates observed since late 2022 (McMaken, 2023).

In contrast, during the 2008-15 period, quantitative easing (QE) programs led to significant growth in the monetary base, but it did not spark unusual growth in M2 or inflation. This occurred because banks essentially swapped bonds for reserves held at the Federal Reserve, indicating that the money supply did not directly translate into increased stock market performance.

Predicting Future Market Movements

Based on historical insights, we can draw the following conclusions for predicting future market movements:

* An increase in money supply, as measured by M2 or MZM, is likely to lead to an increase in stock market performance, while a decrease in money supply may result in a decline in stock market performance.
* Rapid money supply growth may contribute to the formation of stock market bubbles, which could eventually lead to market crashes.
* Monetary policy decisions that affect money supply growth can have significant impacts on stock market performance.

As we look ahead, the upcoming market move will be influenced by monetary policy decisions. If the Federal Reserve maintains its current tightening stance, it is likely that M2 growth will remain negative, which could potentially lead to a decline in stock market performance. However, if the Fed shifts its policy to accommodate economic conditions, we may see a reversal in M2 growth and a corresponding improvement in stock market performance.

In conclusion, the historic move in the U.S. money supply two years ago serves as a reminder of the powerful influence that monetary policy decisions have on stock market performance. As investors, we must stay informed about the relationship between money supply and stock market performance, and remain vigilant in adjusting our portfolios to accommodate potential market moves.