S&P 500: Accounting for the Money Supply

Summary

In this video, the host discusses the S&P 500's performance and its relationship with the money supply. Focusing on a 20% drop followed by a rally to all-time highs, the host explores how factors like unemployment and M2 money supply influence market trends. They highlight historical parallels with the 1998 market and caution against assuming identical outcomes. The discussion also touches on potential risks, including the negative feedback loop and upcoming market movements in Q3, encouraging a long-term, data-driven investment approach.

Takeaways

• 😀 The S&P 500 recently dropped 20%, but it has now reached new all-time highs, demonstrating that market corrections often lead to rallies.
• 😀 Historical patterns show that after a 20% drop, the S&P 500 typically experiences a recovery, although not always to new highs.
• 😀 The unemployment rate has remained steady at 4.2% for a year, which generally supports market growth by reducing downward pressure.
• 😀 The relationship between the S&P 500 and the money supply (M2) can provide insights into market trends, with both generally rising over time.
• 😀 The S&P divided by M2 chart shows a strong similarity to market behavior in 1998, including a 20% drop followed by a recovery to all-time highs.
• 😀 Comparing the current cycle to past periods, like 1998 and the dot-com bubble, highlights the potential for a continued rise, although caution is necessary.
• 😀 The stock market tends to rise until there is a clear reason for it to decline, often driven by a negative feedback loop involving layoffs and reduced demand.
• 😀 A brief drop in the market is not enough to trigger a negative feedback loop; a longer period of decline is typically needed for this to occur.
• 😀 Forecasting market behavior is difficult, and while similarities to past cycles exist, no guarantees can be made about how the current cycle will play out.
• 😀 A long-term investment strategy like dollar-cost averaging (DCA) into low-expense ratio index funds is recommended for investors rather than trying to time the market.

Q & A

How does the speaker relate the S&P 500 to the money supply (M2)?

The speaker highlights that both the S&P 500 and the money supply generally trend upwards over time. By dividing the S&P 500 by M2, they suggest that this ratio can offer valuable insights into the market's current state and potential future movements.

What historical market trend does the speaker reference in relation to a 20% drop in the S&P 500?

The speaker notes that after a 20% drop in the S&P 500, the market typically experiences a strong rally. They provide the example of the 1998 market behavior, where a similar drop led to a rebound to new all-time highs.

What is the significance of the unemployment rate in the context of stock market movements?

The speaker suggests that when the unemployment rate is stable or flat, the stock market tends to rise. A steady unemployment rate signals economic stability, which can support higher market prices. A significant rise in unemployment is seen as a key indicator that could trigger a negative feedback loop in the market.

What does the speaker mean by 'negative feedback loop' in the market?

A negative feedback loop refers to a cycle where lower stock prices lead to layoffs, which reduce consumer demand, causing further price declines and potentially more layoffs. The speaker emphasizes that avoiding this cycle is crucial for continued market growth.

What are the differences between the 1998 market drop and the current market situation?

The speaker notes that the current market situation is similar to 1998 in some ways, such as the pattern of a 20% drop followed by a rally. However, they also point out that the 1998 drop occurred during a period of rising unemployment, while current unemployment rates are still relatively stable.

How does the speaker use the Relative Strength Index (RSI) in their analysis?

The speaker mentions the RSI to compare current market conditions to previous periods, such as the dot-com era. They highlight that the RSI is currently lower than it was in 2000, suggesting that the market may not be as overbought as it was during the dot-com bubble.

What strategy does the speaker recommend for navigating the stock market?

The speaker advocates for a long-term investment strategy of dollar-cost averaging (DCA) into low-expense ratio index funds. This strategy avoids trying to predict short-term market movements and focuses on consistent, steady investing over time.

Why does the speaker believe Q3 might see some market weakness?

The speaker refers to historical market patterns, noting that Q3 has often been a time of market weakness. They point to past examples of market drops occurring in Q3, suggesting that similar volatility could occur in the future.

What does the speaker mean by a 'distribution phase' in the stock market?

A distribution phase refers to a period in the market where investors begin to sell off assets, potentially signaling the end of a market cycle. The speaker suggests that if the S&P 500 divided by M2 breaks through a key level, it could indicate the beginning of such a phase.

How does the speaker view the role of the VIX (Volatility Index) in predicting market movements?

The speaker briefly discusses the VIX, noting that it has remained elevated but could continue to decrease. They suggest that volatility may increase again later in the year, particularly in the August or September timeframe, but caution against relying too heavily on VIX analysis for making investment decisions.