The stock market’s next rally could come from a new batch of stocks.
of S&P 500 Stocks have been hitting new all-time highs one after the other in 2024. A widely used stock market benchmark is up 15% in the first half of 2024 and is up more than 50% from its 2022 bear market lows.
The largest companies are driving the current market rally in the S&P 500. In fact, market concentration has reached levels investors haven’t seen since the 1970s.
The rise in market concentration is the result of a variety of factors. It’s worth noting that many of the largest companies have enjoyed robust revenue growth, as they were well-positioned during the artificial intelligence boom. However, the historical trend of rising concentration has reversed, and one market indicator suggests the tide may be turning.
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The US money supply is finally growing again
According to Khurram Chowdhury, head of European quantitative strategy, declining money supply growth has historically been associated with increased concentration in equities. J.P. MorganSmall businesses can grow more easily when capital is cheap and readily available. When capital is tight, larger businesses have the advantage of being able to use their existing cash flows and balance sheets to fund growth.
Since 2021, we have seen a decline in the M2 money supply, a measure of the money supply in the United States. M2 includes cash in circulation, savings accounts, money market accounts, and certificates of deposit. Basically, all of the money that is easily accessible in the country. By 2022, amid tightening policy by the Federal Reserve, the year-over-year growth rate of M2 money supply became negative. It remained that way until the first quarter of this year.
However, the M2 money supply is finally starting to grow again. In April and May, the M2 money supply increased by about 0.6% year-over-year. Although still well below peak levels in 2022, liquidity is finally increasing.
US M2 Money Supply Year-over-Year Data from YCharts
The money supply could grow further later this year as the Federal Reserve seeks to ease monetary policy constraints. Chairman Jerome Powell has said he plans to cut interest rates once this year, but many analysts believe that’s too modest. Futures markets indicate that a majority of traders expect at least two rate cuts by the end of the year.
Faster money growth could also make it easier for smaller businesses to grow, which could then lead the next phase of the current market rally.
How to invest as money supply growth accelerates
If you expect easing fiscal policy to reverse the sharp rise in market concentration, there are a few ways you can invest.
The easiest way to invest in less concentrated markets is with an equally weighted index fund, such as one like this one. Invesco S&P 500 Equal Weight ETF (RSP 0.04%).
The S&P 500 is a market-cap weighted index, which means that larger companies have a greater impact on the movement of the index than smaller companies. At current market concentration, the top three companies account for more than 20% of the total value of the index. The top 10 companies account for more than 37%. If you invest in a standard S&P 500 index fund, your portfolio will be heavily dependent on just a handful of companies.
In an equal-weighted S&P 500 index fund, the fund invests all of its money equally in all constituent stocks of the S&P 500. The portfolio is rebalanced quarterly to adjust for new companies joining the S&P 500 and older companies leaving the S&P 500. Historically, equal-weighted indexes have outperformed market-capitalization-weighted indexes because smaller companies generally grow faster than the largest companies. However, this has not been the case recently.
Another option is to invest in stocks outside the S&P 500. There are thousands of investable stocks trading in the stock market. The S&P 500 only tracks about 500 of the largest companies. A less concentrated market also gives you an advantage in small and mid-cap stocks. Russell 2000 Like an index fund iShares Russell 2000 ETF (IWM -0.03%) It’s a great way to invest in small cap stocks. Vanguard Extended Market ETF (VXF 0.21%) It provides a way to match the performance of almost every stock in the market except the S&P 500.
While no indicator is always right, an increase in the money supply is not the only indicator that now is a good time to start investing in small businesses. Therefore, with increasing signs of a big change in the stock market, you may want to tilt your portfolio towards these investments.
JPMorgan Chase is an advertising partner of The Ascent, a Motley Fool company. Adam Levy has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends JPMorgan Chase. The Motley Fool has a disclosure policy.
