The increase in US money supply indicates a reversal of the trend towards concentration in US stocks. Small and mid-cap stocks may lead the market into a new phase of rebound

According to the Wisdom Financial APP, the S&P 500 Index hit new highs multiple times in 2024, with a cumulative increase of 15% in the first half of the year, up 50% from the low point of the bear market in 2022. However, the rebound of the S&P 500 Index is led by a few of the largest companies. In fact, market concentration is currently at its highest level since the 1970s.

The increase in market concentration is the result of various factors working together. Many large technology companies have seen steady growth in earnings due to their advantageous position in the artificial intelligence boom. However, historically, the trend of increasing market concentration may soon reverse.

US Money Supply Growing Again

Khuram Chaudhry, Head of Quantitative Strategy for Europe at Morgan Stanley, pointed out that historically, the decrease in money supply growth is related to the increase in market concentration. When loose monetary supply makes funds easily available at low cost, small companies are more likely to grow; when money supply is tight, large companies have an advantage in funding growth using existing cash flow and balance sheets.

Data shows that starting from 2021, the M2 money supply in the United States began to decline. By 2022, against the backdrop of the Federal Reserve tightening monetary policy, the M2 money supply showed a year-on-year negative growth. This situation also occurred in the first quarter of this year.

However, the US M2 money supply has started to grow again. Data shows that in April and May, the US M2 money supply grew by around 0.6% year-on-year. Although still far below the peak levels since 2022, the market is finally seeing an increase in liquidity. Later this year, the Federal Reserve may cut interest rates, further increasing money supply. Federal Reserve Chairman Powell expects only one rate cut this year, but many analysts believe this is too conservative. Futures markets show that most traders currently expect the Fed to cut rates at least twice by the end of this year.

With the acceleration of money supply growth, smaller companies may find it easier to grow. Therefore, these smaller companies may lead the next phase of the current market rebound.

How to Invest as Money Supply Growth Accelerates?

If loose monetary policy reverses the trend of increasing market concentration, investors can invest in several ways. In a scenario of decreasing market concentration, the most direct way to invest is through equal-weighted index funds, such as the Invesco S&P 500 Equal Weight ETF.

Another option is to invest in stocks outside of the S&P 500 Index constituents. The decrease in market concentration will benefit mid-cap stocks. Buying a Russell 2000 Index fund, such as the iShares Russell 2000 ETF, is a good way to invest in small-cap stocks