The US money supply is finally growing again, and that could signal a big change is coming to the stock market

of S&P 500 is setting a new all-time high in 2024. The widely used stock market benchmark rose 15% in the first half of 2024 and is more than 50% off the year’s bear market lows 2022.

The largest companies have led the current market growth in the S&P 500. In fact, market concentration is reaching levels that investors have not seen since the 1970s.

The increase in market concentration is the result of various factors. It’s worth noting that many of the biggest companies have seen solid earnings growth as they’ve been well positioned amid the AI ​​boom. But the upward focus has historically turned, and one market indicator suggests the tide may be about to turn.

The US money supply is finally growing again

Declining money supply growth is historically associated with increased concentration among stocks, according to Khuram Chaudhry, Head of European Quantitative Strategy at JP Morgan. When money is readily available for free, smaller companies can grow more easily. When the supply of money is tight, larger companies have the advantage of using their existing cash flows and balance sheets to finance their growth.

Starting in 2021, we saw a decline in the measure of the money supply in the US called the M2 money supply. M2 includes money in circulation, deposit accounts, money market accounts and certificates of deposit. It is basically all the money readily available in the country. By 2022, amid tightening policies from the Federal Reserve, year-over-year growth in the M2 money supply was negative. It remained so during the first quarter of this year.

But the M2 money supply is finally rising again. In April and May, the M2 money supply increased by about 0.6% year-on-year. While it remains well below its peak levels from 2022, we are finally seeing increasing liquidity.

The money supply could get a further boost later this year as the Fed looks to ease its constraints. Chairman Jerome Powell said he expects to cut interest rates once this year, but many analysts think that is conservative. Futures markets indicate that most traders currently expect at least two interest rate cuts by the end of this year.

As the growth of the money supply accelerates, it may make it easier for smaller companies to grow. As a result, those smaller companies may lead the next step in the current market growth.

How to invest as money supply growth accelerates

If you expect the easing fiscal policies to turn the tide of market concentration, there are several ways you can invest.

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The most straightforward way to invest in bearish market concentration is to use an equally weighted index fund such as Invesco S&P 500 Equal Weight ETF (NYSEMKT: RSP).

The S&P 500 is a cap-weighted index, meaning that larger companies have a greater influence on the movement of the index than smaller companies. At the current level of market concentration, the top three companies account for over 20% of the value of the entire index. Top 10 occupy over 37%. If you invest in a standard S&P 500 index fund, your portfolio depends heavily on just a handful of companies.

With an equal-weight S&P 500 index fund, the fund invests all of your money equally in each component of the S&P 500. The portfolio is rebalanced quarterly and adjusted for new companies joining the S&P 500 and legacy companies that leave. Historically, the equal-weighted index outperforms the equity-weighted index, as smaller companies generally grow faster than larger companies. However, recently this has not been the case.

Another option is to invest outside the S&P 500. There are thousands of investable stocks that are traded on public exchanges. The S&P 500 tracks only about 500 of the largest companies. Declining market concentration would also favor small- and mid-cap stocks. Buying shares of a Russell 2000 index fund like iShares Russell 2000 ETF (NYSEMKT: IWM ) is a great way to gain exposure to small caps. of Vanguard Extended Market ETF (NYSEMKT: VXF ) offers a way to match the performance of almost every stock in the market except for those in the S&P 500.

While no indicator is right all the time, the increased money supply isn’t the only factor that suggests now might be a good time to start investing in smaller companies. So, you might want to tilt your portfolio towards investments like the ones above as more and more signs point to a big change in the stock market.

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The U.S. money supply is finally growing again and could signal a big change coming to the stock market was originally published by The Motley Fool