By Mark Hulbert
Our monthly review of stock-market valuation indicators
The stock market will barely keep pace with inflation over the next decade.
That's the implication of a valuation model based on the ratio of the S&P 500 SPX to the M2 money supply. M2, which is calculated by the Federal Reserve, is an estimate of the total money supply in the U.S. It includes cash in circulation, checking and savings accounts, and money-market funds. Higher values of the ratio are correlated with lower subsequent equity returns - and vice versa.
The accompanying chart plots the ratio since 1970, along with the S&P 500's subsequent 10-year annualized real total return. Over the last 54 years, the ratio hit its lowest (and most bullish) level at the bear-market bottom in 1982, when it stood at 0.06. Its highest level since 1970 was registered at the top of the dot-com bubble in 2000, at 0.32.
The S&P 500/M2 ratio currently stands at 0.25, close to the bearish extreme of the historical range. Based on the historical correlations between the ratio and the stock market's subsequent return, a ratio of 0.25 translates to an expected real total return between now and 2034 of just 0.1% annualized.
The ratio's theoretical basis is, to put it loosely, the notion that "money makes the world go round." More money in circulation will eventually find its way into equities, just as less will lead to a withdrawal of liquidity from the stock market. While one can object to the ratio on a number of theoretical grounds, its strong statistical foundation means it deserves to be included in the list of valuation models that are normally featured in this monthly column. The R-squared of the correlation between the ratio and the stock market's subsequent 10-year return is a statistically significant 49% since 1970.
How valuation models stack up currently
The S&P 500/M2 ratio's projection over the next decade is in line with what other indicators are saying about the future of returns. It would have been curious if, despite also having a strong statistical foundation, this ratio signaled something different from the other indicators in the table below. But it doesn't: Each of those others also forecasts well-below-average returns between now and 2034, if not outright losses.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com.
-Mark Hulbert
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07-23-24 0715ET
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