Navigating the Shifting Tides: How Accelerating U.S. Money Supply Could Reshape the Stock Market

The U.S. stock market has been on a remarkable run, with the S&P 500 index climbing over 20% through 2024. However, this rally has been driven primarily by a handful of the largest companies, leading to increased market concentration. As the Federal Reserve's monetary policies evolve, the dynamics of the market could be poised for a significant shift, potentially favoring smaller companies and less concentrated sectors.

Unlocking the Potential of Accelerating Money Supply

The Ebb and Flow of Money Supply

The U.S. money supply, as measured by the M2 metric, has experienced a rollercoaster ride in recent years. After a surge in 2020 due to pandemic-related stimulus measures, the money supply growth slowed and even contracted in 2022 and 2023 as the Federal Reserve tightened its monetary policy to combat inflation. However, this trend is now reversing, with M2 money supply growth accelerating once again.As the Federal Reserve institutes interest rate cuts, the cost of borrowing will decrease, making it easier for smaller companies to access capital and expand their operations. This increased liquidity in the market could lead to a shift in market dynamics, potentially favoring smaller and more agile firms over the dominant megacap stocks that have driven the recent market rally.

The Implications of Changing Market Concentration

The current market landscape is heavily skewed towards a handful of the largest companies, with the top 10 stocks accounting for around 35% of the S&P 500's value – the highest level since the 1960s. This concentration has been a double-edged sword, as the outperformance of these megacap stocks has propelled the broader market higher, but it also raises concerns about the sustainability of such a narrow market leadership.As money supply growth accelerates, the playing field could start to level, allowing smaller companies to gain a more prominent foothold in the market. This shift could lead to a more diversified and balanced market, where the performance of the index is less dependent on the fortunes of a few dominant players.

Investing Strategies for a Changing Market

Investors looking to capitalize on the potential shift in market dynamics have several options to consider. One strategy is to invest in equal-weight index funds, such as the Invesco S&P 500 Equal Weight ETF (RSP). These funds allocate an equal amount of capital to each component of the index, rather than weighting them by market capitalization. This approach can help mitigate the impact of the largest companies and provide exposure to a more diverse range of stocks.Another option is to focus on small-cap stocks, which are often overlooked in the broader market rally. The S&P 600 Small Cap Index, tracked by the SPDR Portfolio S&P 600 Small Cap ETF (SPSM), offers exposure to some of the most agile and innovative companies in the U.S. market. As money supply growth accelerates, these smaller firms may be better positioned to capitalize on new opportunities and outperform their larger counterparts.

Navigating the Shifting Landscape

The U.S. stock market is poised for a potential shift as the Federal Reserve's monetary policies evolve and the money supply growth accelerates. This change could signal the end of the megacap-driven market rally and the beginning of a more balanced and diversified market landscape.Investors who are able to adapt to these changing dynamics and position their portfolios accordingly may be well-positioned to capitalize on the opportunities that arise. By considering strategies like equal-weight index funds and small-cap stocks, investors can potentially benefit from the market's transition and position themselves for long-term success.