Leading economic data for 5th time in 153 years issues dire alarm to Wall Street

Whether you realize it or not, stock market corrections, crashes and bear markets are a normal part of investing. Benchmarking since the early 1950s S&P 500 (^GSPC -1.45%) It has experienced 39 double-digit declines, according to data provided by sell-side consultancy Yardeni Research.

Last year was the latest of those 39 notable moves.Ageless Dow Jones Industrial Average (^ DJI -1.07%)broad S&P 500, and growth dependent NASDAQ Composite (^IXIC -1.76%) All were in a bear market, ending 2022 with losses of 9%, 19% and 33% respectively. These represent the worst returns for all three of his major U.S. indices since 2008.

But if one of the major economic indicators has anything to say about it, the worst is yet to come for Wall Street.

Image Source: Getty Images.

It’s the fifth serious warning issued to Wall Street since 1870.

Before digging in, let’s state the obvious. No concrete indicator is 100% certain to predict exactly when a bear market or crash will occur, how long it will last, or how steep the decline will be.

But throughout history, there have been indicators that have provided perfect or near-perfect predictions when it comes to predicting recessions or predicting the next direction of the stock market. The US money supply is one such major economic indicator with an extensive track record of success within certain parameters.

The two money supply metrics that are commonly tracked are known as M1 and M2. M1 takes into account the amount of banknotes and coins currently in circulation, as well as traveler’s checks. In other words, M1 is the money in your pocket, or money at your fingertips. M2 creates all of M1’s accounts, but adds savings accounts, bank certificates of deposit (CDs) for less than $100,000, and money market funds. This is money that can be accessed very quickly, but you have to do a little more work to get it.

The stark warning to Wall Street is related to M2, thanks to data presented by Nick Geril, CEO and founder of Rventure Consulting, on the social media platform Twitter.

Jerrill used historical M2 and US inflation data from the Federal Reserve Bank of St. Louis and the US Census Bureau to plot how the money supply and inflation/deflationary pressures sometimes correlate.

WARNING: The money supply is officially shrinking. 📉

This has only happened four times in the last 150 years.

Each time the Great Depression followed with double-digit unemployment. 😬 pic.twitter.com/j3FE532oac

— Nick Gurli (@nickgerli1) March 8, 2023

As you can see from Geril’s graph above, only five times since 1870 has the US money supply (M2) fallen by at least 2% year-over-year. Of the last four outbreaks, three followed by economic recessions and one panic, in each case he experienced double-digit unemployment. It is now the fifth time in the last 153 years that M2 has declined by at least 2%.

The question at hand is how even a modest reduction in the money supply will affect an economy with relatively high inflation, such as the one the US is currently experiencing. and eventually something will break. We expect a sharp slowdown in purchasing activity and a general weakening in pricing power, including in energy commodities such as oil and natural gas.

You might be wondering why a fall in M2 is a concern for Wall Street, as the stock market doesn’t always trade in step with the US economy. The answer is simple. The stock market hasn’t bottomed out since World War II. Before to the National Bureau of Economic Research declaring a recession. If M2 portends a period of deflation/recession, it means stocks are not close to bottom yet.

M2 isn’t Wall Street’s only concern

As we’ve pointed out in recent weeks, M2 is just one of many leading indicators predicting a recession in the not-too-distant future.

One of the most tracked recession probability tools is the New York Federal Reserve’s Recession Probability Index. This forecast indicator measures the difference between 3-month Treasury yields and 10-year Treasury yields (called the “spread”). Yield inversions (short-term bonds yielding higher than long-term bonds) are often a sign of trouble ahead for the U.S. economy.

Mar-10 Treasury Yield Spread Data from YCharts. Gray zones indicate recessions.

As of last week, the magnitude of the yield curve inversion between 3-month and 10-year Treasuries reached its highest level since 1981. Meanwhile, the New York Fed’s Recession Probability Index suggests a 57.13% chance of a recession. next 12 months. Over the past 56 years, a recession has occurred every time this indicator has exceeded his 40%.

Another forecasting tool with an astonishing track record of predicting recessions is the Conference Board Leading Economic Index (LEI). The LEI takes into account 10 economic inputs and is expressed as a 6-month annual growth rate.

Since 1949, whenever the LEI fell by at least 4%, it was immediately followed by a recession. His December reading on the Conference Board LEI was -4.2%.

Similarly, the US ISM Manufacturing New Orders Index, a subcomponent of the better-known ISM Manufacturing Index (also known as the “Purchasing Managers Index”), portends trouble.

Use the ISM Manufacturing New Orders Index to explore the strength of US industrial orders. This is a metric that is measured on a scale of 0 to 100, with 50 being a neutral baseline. A number above 50 means an expansion of the industrial order, a number below 50 suggests a contraction. It read 42.5 in January 2023 before rebounding in February. For the past 70 years, readings below 43.5 have portended a recession.

Image Source: Getty Images.

Smart investors keep their money under control

It is important to note that M2 has a history of predicting recessions or depressions when the economy declines by at least 2%, but all of these events occurred between the 1870s and 1930s. The Federal Reserve has a much better understanding of how to adjust monetary policy to influence changes in the US economy than it did 100 years ago.

Similarly, the federal government’s ability to use fiscal policy tools to support the US economy is much more sophisticated than it was in the 1870s and 1890s. A number of indicators point to an impending economic downturn, but a recession seems unlikely.

Furthermore, M2 is rather Money during the COVID-19 pandemic. A 2% or 3% decline in the money supply caused problems a century ago, but the expansion of M2 from $15.3 trillion to nearly $21.3 trillion between December 2019 and January 2023 , could allow for a significant contraction without severely damaging the U.S. economy.

The point to make is that, as so many indicators suggest, smart investors will continue to invest their money even when a recession is imminent.

^ SPX data from YCharts. Gray zones indicate recessions.

Each year, market analyst firm Crestmont Research estimates what the total return, including dividends paid, would have been if investors had bought and held the S&P 500 Tracking Index at any point since the early 1900s. We are updating historical data on how to generate 20 years.

Among the 104 end years studied (1919-2022), Crestmont found that all 20-year periods produced positive total returns. In fact, more than 40% of him in the final year we studied had a 20-year annual total return of at least 10.8% for him.

The Dow Jones Industrial Average, S&P 500, and Nasdaq Composite have rough patches, but they tend to rise in value over time. For long-term investors, every time these indices fall by his double-digit percentages, it’s a great opportunity to buy high-quality stocks at discounted prices.