The US money supply is finally increasing again, which could signal a big change in the stock market

THE S&P 500 sets one new all-time high after another in 2024. The widely used stock market benchmark climbed 15% in the first half of 2024, and is up more than 50% from the 2022 bear market lows.

The largest companies are driving the current rally in the S&P 500. In fact, market concentration is at levels investors haven't seen since the 1970s.

The increasing market concentration is the result of several factors. It’s worth noting that many of the largest companies have seen solid earnings growth because they were well-positioned for the rise of artificial intelligence. But this increasing concentration has historically reversed, and one market indicator suggests that trend may be about to reverse.

US Money Supply Finally Increases Again

The decline in money supply growth has historically been linked to increased equity concentration, according to Khuram Chaudhry, head of European quantitative strategy at JP Morgan. When money is readily available at low cost, small businesses can grow more easily. When money supply is limited, large businesses have the advantage of using their existing cash flow and balance sheet to finance their growth.

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

But M2 money supply is finally increasing again. In April and May, M2 money supply increased by about 0.6% year-on-year. While still well below its record levels of 2022, we are finally seeing an increase in liquidity.

US M2 Money Supply YoY data by YCharts

Money supply could be further strengthened later this year as the Fed seeks to ease its constraints. Chairman Jerome Powell has said he expects to cut interest rates once this year, but many analysts believe that is a conservative forecast. Futures markets indicate that the majority of traders currently expect at least two interest rate cuts by the end of the year.

Accelerating money supply growth could facilitate the growth of small businesses, which could lead the next stage of the current stock market recovery.

How to Invest as Money Supply Growth Accelerates

If you believe that easing fiscal policy will reverse the sharp rise in market concentration, there are several ways to invest.

The easiest way to invest in a decreasingly concentrated market is to use an equal-weight index fund like the 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 influence on the index’s performance than smaller ones. Given the current level of market concentration, the top three companies account for more than 20% of the index’s total value. The top 10 account for more than 37%. If you invest in a standard S&P 500 index fund, your portfolio is heavily reliant on just a handful of companies.

With an equal-weighted 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 as new companies join the S&P 500 and old ones leave. Historically, the equal-weighted index outperforms the market-cap-weighted index because smaller companies tend to grow faster than larger ones. However, that hasn't been the case recently.

Another option is to invest outside the S&P 500. There are thousands of stocks to invest in, traded on public exchanges. The S&P 500 only tracks about 500 of the largest companies. Decreasing market concentration would also favor small- and mid-cap stocks. Buying shares of a Russell 2000 index funds like the iShares Russell 2000 Exchange Traded Fund (ETF) (JMW -0.03%) is a great way to get exposure to small caps. Vanguard Extended Market ETF (VXF 0.21%) offers a way to match the performance of almost every stock on the market except those in the S&P 500.

While no indicator is accurate all the time, money supply growth isn't the only factor that suggests now might be a good time to invest in small businesses. So you might want to tilt your portfolio toward investments like those mentioned above as more and more signs point to a significant shift in the stock market.

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 has a position in and recommends JPMorgan Chase. The Motley Fool has a disclosure policy.