Investing isn't a sprint -- it's a marathon. When examined over long stretches, stocks have the annualized return edge over other asset classes, such as bonds and commodities. But over the short term, stock market returns can be unpredictable.

Last year, the widely followed Dow Jones Industrial Average (^DJI 0.56%), broad-based S&P 500 (^GSPC -0.88%), and growth-dependent Nasdaq Composite (^IXIC -2.05%) all slid into respective bear markets and produced their worst full-year returns since the Great Recession. It was a reminder to all that stocks can, indeed, move lower.

A twenty-dollar-bill paper airplane that's crashed and crumpled into the business section of a newspaper.

Image source: Getty Images.

But it's not the only warning Wall Street is receiving that near-term turbulence could pick up. The U.S. money supply is doing something truly historic at the moment, and there's a chance it may be foreshadowing a big move to come for stocks.

U.S. money supply might be signaling something historic for Wall Street

Let's be honest: U.S. money supply isn't exactly a leading indicator investors seek out when they're trying to determine which direction the stock market will move next. Normally, investors will lean on corporate earnings, Federal Reserve monetary policy, leading employment/labor statistics, and even U.S. gross domestic product before they consider money supply as a pertinent stock market-moving indicator.

But over the past couple of years, we've witnessed history on both sides of the aisle when it comes to U.S. money supply.

Before digging into that specific history, it'd probably help to define what "money supply" actually means. The money supply indicators most economists and investors track are M1 and M2. The former accounts for all cash and coins in circulation, as well as ready-to-spend assets like traveler's checks. Meanwhile, M2 incorporates everything in M1, with the addition of savings accounts, money market funds, and certificates of deposit (CDs) at the bank for less than $100,000.

Essentially, M1 is money you can spend at a moment's notice, whereas M2 can be spent with relative ease, but it's cash that's a little tougher to get to. M2 is where we're witnessing some never-before-seen changes.

US M2 Money Supply Chart

US M2 Money Supply data by YCharts.

M2 money supply has made history twice over the past two years

M2 has been trending higher since 1959, which is as far back as the data from the Board of Governors of the Federal Reserve goes. However, it really skyrocketed during the COVID-19 pandemic. The issuance of multiple rounds of stimulus checks, coupled with the nation's central bank purchasing Treasury bonds and mortgage-backed securities (collectively known as quantitative easing (QE)), sent M2 screaming higher by 26% on a year-over-year basis. This was, by far, the fastest increase in U.S. money supply on record.

Now we're witnessing the opposite. As of March 2023, reported M2 data showed a 4.1% year-over-year decline. Reventure Consulting founder and CEO Nick Gerli referenced data from the U.S. Census Bureau and Federal Reserve Bank of St. Louis to develop a chart of M2 dating back to 1870. According to Gerli, this is only the fifth time in 153 years -- and the first time in 90 years -- that M2 has declined by at least 2% on a year-over-year basis.

Note: Gerli's tweet is two months old, which is why the decline referenced is 2% and not the current 4.1%.

The reason money supply matters to investors is because it's the foundation from which the U.S. economy is built. If inflation is above its historic norm, consumers and businesses will need more capital to purchase their necessities and discretionary goods and services. But if M2 is declining and inflation is still above historic norms, there may not be enough money for discretionary purchases or other goods and services. Declining M2 may signal deflationary pressures to come that could lead to lower corporate earnings and a recession.

In one respect, a decline in money supply would make sense after we witnessed a historic expansion of M2 during the pandemic on the heels of stimulus checks and QE. Growth in M2 was responsible for the highest U.S. inflation rate in more than 40 years. Contraction of the money supply is expected, given the Federal Reserve's aggressive rate-hiking cycle.

The concern is that drops in M2 of at least 2% haven't, historically, been good news for the stock market or the U.S. economy. The other four times M2 dropped by at least 2%, there were three depressions and one panic.

Keep in mind that some of these events happened before or just shortly after the creation of the Federal Reserve. With nearly 110 years of history now under its belt, the nation's central bank has a wealth of knowledge with regard to tackling economic downturns. This makes a Great Depression-like move lower in the stock market highly unlikely today.

While a 4.1% decline in money supply may be potentially benign given how much M2 expanded two years ago, it could also signal a recession. After World War II, no bear market has found its bottom prior to an official recession being declared. In other words, the significant move lower in M2 appears to be foreshadowing new lows to come for the Dow Jones Industrial Average, S&P 500, and Nasdaq Composite.

A businessperson closely reading the financial section of a newspaper.

Image source: Getty Images.

Investors have time on their side

Over the next couple of months, M2 could be the single most telling indicator of what's to come for the U.S. economy and stock market. But M2's predictive capacity pales in comparison to the power of time on Wall Street.

Although stock market downturns aren't welcomed by most investors, they occur more frequently than you probably realize. Data from sell-side consultancy firm Yardeni Research shows that there have been 39 separate double-digit drops in the S&P 500 since the start of 1950. On average, investors have witnessed a double-digit decline in the benchmark index every 22.5 months over the past 73 years.

But there's another way of looking at this dataset. If you exclude the current bear market for the Nasdaq Composite and the downturn for the Dow and S&P 500, each and every one of the previous 38 double-digit declines was eventually swept away by a bull market. Despite never knowing when a correction will occur, how long it'll last, or how steep the drop will be, history has shown time and again that every downturn in the major U.S. stock indexes is eventually recouped by a bull market.

To add to this point, the Dow Jones, S&P 500, and Nasdaq Composite spend a disproportionate amount of time in a bull market. Roughly one year ago, I calculated the number of calendar days the stock market spent in bull and bear markets dating back to the start of 1950. In total, around 7,300 calendar days were spent in some form of correction, while more than 19,100 days were spent in a bull/rising market. For every calendar day in correction, Wall Street has historically spent 2.6 calendar days in a bull market.

Put simply, patience continually pays off on Wall Street. While having cash at the ready to take advantage of potential future discounts in equities is always a smart move, investors shouldn't hesitate to put capital to work right now if they're looking to the horizon and leaning on time as an ally.