Table of Contents
The S&P 500 divided by M2 money supply just flashed the same signal that preceded the dot-com bubble burst.
Key Takeaways
- The S&P 500 recently hit new all-time highs after a classic 20% correction, following historical precedent perfectly
- S&P 500 divided by M2 money supply shows an almost identical pattern to the 1998 setup before the dot-com crash
- Current market behavior mirrors 1998 so closely that overlaying the charts makes them nearly indistinguishable
- Unemployment rate has remained flat at 4.2% for over a year, which historically supports continued market strength
- Monthly RSI at 67 is approaching but hasn't reached the dangerous 73 level seen at the 2000 market peak
- Markets typically grind higher until they have a compelling reason to go down, not the other way around
- Q3 weakness patterns suggest August-September could bring volatility, following historical precedent
- The key difference from 1998: unemployment started from much lower levels this cycle (3.4% vs 3.8%)
- Distribution phases at market tops are extended processes lasting 18+ months, not sudden events
- Dollar-cost averaging into low-cost index funds remains the most reliable long-term strategy despite short-term uncertainties
The Chart That Makes Wall Street Nervous
There's this one chart that's been quietly making the rounds among serious market analysts, and honestly, it's both fascinating and a little unsettling. When you take the S&P 500 and divide it by the M2 money supply, you get this incredible window into market dynamics that most people never see.
Here's what's wild about it: the S&P just got rejected at the exact same level where it got rejected in 1998. Not similar. Not close. The exact same level. And in both cases, what followed was a 20% drop and then a surge back to all-time highs. The pattern recognition here isn't some vague technical analysis - it's mathematical precision that's honestly kind of eerie.
What makes this even more compelling is how the entire sequence has played out. We had that April drop that perfectly swept the low from April 2024, which is a classic pattern that historically leads to strong bounces. Then we got exactly that - a rally that took us not just back to previous highs, but to new all-time highs entirely.
- The S&P/M2 ratio rejection occurred at identical levels in 1998 and 2024, suggesting powerful resistance
- Both instances featured 20% corrections followed by new all-time high breakouts
- The April 2025 low swept April 2024's low, a pattern that historically generates strong rallies
- Current price action mirrors 1998 so closely that chart overlays are nearly indistinguishable
The thing about using the money supply to analyze stock markets is that it strips away a lot of noise. Both the S&P 500 and M2 money supply generally trend up and to the right over time, but their relationship reveals when stocks are getting ahead of themselves relative to the underlying monetary environment.
What we're seeing now is that same setup where stocks have pushed to levels that historically mark important turning points. It doesn't mean an immediate crash is coming - the 1998 pattern actually continued higher for quite a while before the eventual dot-com bust. But it does suggest we're in a critical zone where things could get interesting.
The unemployment rate staying flat at 4.2% for over a year is actually a big part of why this rally has been sustainable. When unemployment is steady, markets tend to grind higher because there's no compelling reason for them to go down. It's only when unemployment starts breaking higher that you get those negative feedback loops everyone fears.
Why This 1998 Comparison Should Keep You Awake
Let me show you something that's going to blow your mind. If you take the market action from October 2022 and overlay it with what happened starting in 1996, the patterns are so similar that you literally can't see the current cycle when both charts are displayed together. They're practically carbon copies of each other.
But here's where it gets really interesting - and a little scary. Back in 1998, after that initial drop and recovery, the market continued climbing for quite a while. We're talking about a year and a half of grinding higher before things finally rolled over in a meaningful way. The top wasn't a single event; it was this extended distribution phase that lasted from February 1999 until November 2000.
That's the thing about market tops - they're processes, not events. While bottoms tend to happen relatively quickly with sharp, violent moves, tops are these long, drawn-out affairs where optimism slowly gets chipped away over months or even years.
- Chart overlay analysis shows current patterns are nearly identical to 1996-1998 setup
- The 1998-2000 top was an 18-month distribution process, not a sudden crash
- Market tops are extended affairs driven by persistent optimism, unlike sharp bottoms
- Current monthly RSI of 67 approaches but hasn't reached the dangerous 73 level from 2000
What's particularly fascinating is looking at the RSI readings. Right now, we're sitting at 67 on the monthly RSI for the S&P 500. Back in 2000, when everything finally rolled over, we were at 73. So we're not quite there yet, but we're definitely in the neighborhood of levels that have historically marked significant tops.
The monthly RSI was actually putting in lower highs for a while before that 2000 crash, and you could argue something similar is happening now. But this is where timing becomes absolutely crucial - and incredibly difficult. This stuff takes years to play out, and even if you correctly identify the pattern, the chances of timing it perfectly are pretty slim.
What makes this comparison both compelling and dangerous is how easy it is to get caught up in the pattern recognition and forget that markets don't have to follow historical precedent exactly. The current environment has differences that could change how things unfold.
The Unemployment Rate: The Make-or-Break Factor
Here's the key variable that could determine whether we follow the 1998 playbook exactly or carve out our own path: the unemployment rate. Right now, it's been remarkably stable at 4.2% for over a year, and that stability is actually a big reason why stocks have been able to grind higher despite various concerns.
But there's an important difference between now and 1998 that's worth understanding. Back then, when we had that market drop in 1998, the unemployment rate was in a macro downtrend - it was improving. This time around, we've been seeing the unemployment rate gradually tick higher, though it's still not at levels that historically trigger recessions.
The critical threshold seems to be around 4.3-4.4%. That's where the unemployment rate was when the 2001 recession actually began, and it marked the point where markets finally accepted that economic weakness was real rather than temporary.
- Unemployment has remained flat at 4.2% for over a year, supporting continued market strength
- The 1998 setup featured improving unemployment, while current environment shows gradual deterioration
- Historical recession trigger point appears around 4.3-4.4% unemployment
- Current cycle started from much lower unemployment (3.4%) than previous cycles (3.8%)
What's interesting is that this cycle saw unemployment go all the way down to 3.4%, which is basically as low as it's been since 1969. So even though we're seeing some uptick, we're starting from a much lower base than previous cycles. That could provide more cushion before we reach levels that historically matter for market performance.
The reason the market has been able to shrug off the gradual increase in unemployment so far is probably because we haven't reached those critical levels yet. But the moment unemployment starts breaking meaningfully higher - especially if it pushes above 4.5% - that's likely when you'd start seeing the negative feedback loop everyone talks about.
That negative feedback loop works like this: lower stock prices lead to layoffs, which lead to lower consumer demand, which leads to lower corporate earnings, which leads to lower stock prices and more layoffs. It's a vicious cycle that feeds on itself once it gets started.
The key is that you need sustained weakness at lower prices to trigger this loop, not just a quick drop and recovery like we saw in April. As long as markets can rally back to new highs quickly after corrections, companies maintain confidence and avoid the layoffs that would kick off the negative spiral.
The Q3 Weakness Pattern Nobody Talks About
There's this recurring pattern in markets that doesn't get nearly enough attention: Q3 weakness. Specifically, when you get a significant drop in March, there's often corresponding weakness in August. It's not a guarantee, but it's happened enough times that it's worth paying attention to.
Looking at historical examples, the 2000 era had drops in Q1 followed by Q3 weakness. The 2008 crisis featured a March drop, then a rally to new highs, followed by serious problems in August. The pattern isn't universal, but it's frequent enough to be on the radar.
The theory behind Q3 weakness makes intuitive sense. March drops often coincide with end-of-quarter portfolio adjustments and tax-related selling. Markets then rally through Q2 as conditions improve and optimism returns. But by Q3, especially August and September, you get back-to-school reality checks, summer vacation liquidity issues, and the general tendency for institutional money to be less active.
- Historical pattern shows March drops often followed by August-September weakness
- Q2 rallies frequently bridge the gap between Q1 and Q3 volatility periods
- August-September timeframe coincides with reduced institutional activity and liquidity
- VIX volatility measures suggest potential for increased volatility later in summer
What's particularly relevant now is that we got exactly the March weakness that was anticipated, followed by the Q2 rally that was expected. If the pattern holds, we might see some choppiness in August-September, but that doesn't necessarily mean immediate stock market weakness.
The VIX has been coming down from elevated levels, but it's still above normal ranges. That suggests there's still volatility supply in the system that could manifest during traditionally weak periods. The question is whether any Q3 weakness would be another buying opportunity like April, or something more sustained.
The key thing to watch is how markets handle any August weakness. If we get a pullback that holds above the April lows and then rallies again, that would be consistent with the 1998 playbook of grinding higher over time. But if we start breaking below key support levels, especially with unemployment ticking higher, that could signal something more serious developing.
Why the Money Supply Matters More Than You Think
The reason the S&P 500 divided by M2 money supply is such a powerful indicator is that it accounts for the underlying monetary environment that drives asset prices. Both the stock market and money supply tend to trend higher over time, but their relationship reveals when asset prices are getting ahead of the fundamental monetary backdrop.
When this ratio gets to extreme levels, it historically marks important turning points. Not necessarily immediate reversals, but zones where the risk-reward starts shifting meaningfully. What we're seeing now is that we're back to levels that previously marked significant resistance.
The beauty of this approach is that it strips away a lot of the emotional noise that surrounds market analysis. Instead of trying to guess whether news is good or bad, you're looking at the mathematical relationship between asset prices and the money supply that theoretically supports those prices.
- S&P/M2 ratio provides objective measure of market valuation relative to monetary backdrop
- Extreme ratio levels historically coincide with major market turning points
- Current levels match previous resistance zones that marked significant tops
- Ratio analysis removes emotional bias and focuses on mathematical relationships
What's particularly compelling about the current setup is how cleanly it aligns with the 1998 pattern. We're not talking about rough approximations or subjective interpretations. The levels are mathematically identical, which suggests we're dealing with fundamental market dynamics rather than coincidental technical patterns.
The challenge, of course, is that just because we're at levels that previously marked tops doesn't mean we have to reverse immediately. The 1998 example shows that markets can continue grinding higher for extended periods even after reaching these levels. The key is understanding that we're in a zone where risk is elevated and the asymmetric upside that existed earlier in the cycle has diminished.
This doesn't mean becoming bearish or trying to time a crash. It means being more cautious about adding aggressive risk and perhaps taking some profits if you've had a good run. The worst thing you can do with this kind of analysis is try to get too cute with timing. The patterns are useful for understanding risk levels, not for precision market timing.
The Reality of Long-Term Investing in Uncertain Times
Here's something that might sound boring compared to all this technical analysis, but it's probably the most important point: the best long-term strategy remains dollar-cost averaging into low-cost index funds regardless of where we are in market cycles.
I know that sounds like a cop-out when we're discussing sophisticated technical patterns and historical comparisons, but it's actually the most practical approach for most investors. The reality is that even with all this analysis, nobody knows exactly how markets will unfold or when major moves will happen.
The 20% drop we just experienced was a perfect example of why systematic investing makes sense. If you were dollar-cost averaging through that period, you automatically bought more shares at lower prices without having to time anything. Now that we're at new highs, those lower-cost shares are contributing to returns.
- Dollar-cost averaging eliminates the need for precise market timing while capturing long-term trends
- 20% corrections provide automatic buying opportunities for systematic investors
- Long-term index fund investing historically outperforms active timing strategies
- Market volatility becomes advantageous rather than problematic with consistent buying programs
The challenge with technical analysis like the S&P/M2 ratio is that it's better for understanding risk levels than for making specific buy/sell decisions. You might correctly identify that we're in a riskier environment, but that doesn't tell you whether to expect weakness next month or next year.
What you can do is use this kind of analysis to inform position sizing and risk management. If we're potentially in the later stages of a market cycle, it might make sense to be less aggressive about adding new positions while maintaining your core systematic investing approach.
The key insight is that markets tend to grind higher until they have a compelling reason to go down. Right now, with unemployment stable and no immediate economic crisis, there's no compelling reason for sustained weakness. That could change, especially if unemployment starts breaking higher, but until it does, the path of least resistance remains up.
The 1998 comparison suggests that even if we're setting up for eventual weakness, that weakness might not materialize for quite some time. Trying to time it perfectly is likely to result in missed gains during what could be an extended grinding higher phase.
Better to understand the risks, manage position sizing appropriately, and stick with proven long-term strategies while staying alert to changing conditions. The patterns are useful for context, not for tactical trading decisions.
