The U.S. Money Supply Just Hit an All-Time High -- and It May Mean Trouble for Wall Street
News Summary
The U.S. M2 money supply recently hit a record $22.2 trillion. While M2 typically grows gradually with the economy, its steady rise since October 2023 reflects banks anticipating a resumption of Federal Reserve rate cuts and consequently increasing lending activity. An expanded money supply growing faster than economic output typically leads to rising inflation. Some of this excess money finds its way into stocks, pushing the S&P 500 and Nasdaq Composite to all-time highs. Despite healthy corporate earnings (S&P 500 earnings projected to grow 8% in Q3), the article warns that current market valuations are stretched, with the forward 12-month P/E for the S&P 500 at 22.8 and the Shiller P/E just over 40, nearing levels seen before the dot-com bubble burst and exceeding those before the 1929 crash, suggesting the market may be in "bubble territory."
Background
M2 is a key measure of the U.S. money supply, encompassing hard currency, liquid bank deposits, money market accounts, and some smaller certificates of deposit (CDs). Economists closely monitor M2 due to its significant impact on economic growth, inflation, and, crucially for investors, the stock market. From early 2022 to late 2023, the Federal Reserve tightened monetary policy by raising interest rates and selling government securities to combat runaway inflation in the wake of the COVID-19 pandemic, which caused the M2 money supply to fall. However, since October 2023, M2 has been steadily rising as banks began to expect a resumption of rate cuts by the Fed and started lending more generously.
In-Depth AI Insights
How sustainable is the current surge in money supply and accompanying stock market valuation spike in the long term? - While innovations like AI could boost productivity and justify higher valuations over the long run, the article explicitly states that the current stock market rally is primarily driven by M2 money supply, not solely by corporate earnings growth. - This suggests the market might be forming a liquidity-driven bubble rather than one based on fundamentals. This liquidity-fueled valuation could face a severe test once the Fed's policy stance shifts or market expectations for future rate cuts change. - Investors should be wary, as stock prices ultimately track earnings growth over the long term, not short-term money supply fluctuations. Current valuation levels, especially when compared to historical bubble periods, signal potential risks. What are the practical implications of Federal Reserve monetary policy expectations on market sentiment and bank lending behavior? - The article highlights that banks' expectations of the Fed resuming rate cuts are a key driver for their "more generous lending," directly contributing to the rise in M2. - This underscores the central role of expectations management in monetary policy transmission. Market perceptions of future interest rate paths, rather than just current policy rates, are profoundly influencing bank credit creation and overall financial conditions. - During President Donald J. Trump's incumbent term, his administration may favor loose monetary conditions to stimulate economic growth and stock market performance, potentially exerting subtle pressure on the Fed's independence, thereby influencing rate cut expectations. What does the current market's "bubble territory" status imply for different asset classes? - For equities, high valuations combined with expanding money supply suggest an increased risk of correction, particularly for sectors and companies whose earnings growth doesn't adequately support their share prices. - For bond markets, if the surge in money supply indeed leads to higher-than-expected inflation, the Fed's path to rate cuts could be hindered, or even reversed towards tightening, negatively impacting fixed-income assets. - In this environment, investors might seek assets that can hedge against inflation or possess strong fundamental backing, such as certain commodities or high-quality companies with sustained earnings power.