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When examined through a broader lens, the stock market offers a path to long-term wealth creation. However, as that lens narrows, symbolic directional movements become less predictable. Dow Jones Industrial Average (^DJI 0.16%)standard S&P500 (^GSPC 0.03%)and growth potential Nasdaq Composite (^IXIC -0.28%) thrown out the window.
Investors are elated about the new bull market, but the Dow Jones, S&P 500, and Nasdaq Composite have bounced back and forth between bear and bull markets consecutively since 2020. It is very likely that this pattern will continue in 2024 and the stock price will plummet again.
While there is no such thing as a predictive indicator or economic data point that can predict the short-term direction of the Dow, S&P 500, or Nasdaq Composite with 100% accuracy, there are some indicators and metrics that are strongly correlated. Stock market movements throughout history. One such indicator is I never have That this was wrong, given the specific circumstances, provides an ominous warning to investors in 2024.
Image source: Getty Images.
This recession prediction tool has an impeccable track record dating back over 60 years.
Although the word “impeccable” is rarely used on Wall Street, the Conference Board Leading Economic Index (LEI) has a truly impeccable track record when it comes to predicting U.S. recessions.
The LEI is reported monthly (usually in the third week of the month) and contains 10 entries. Three of these inputs are financial in nature, such as the performance of the S&P 500, while the other seven are non-financial, for example, the ISM Manufacturing New Orders Index, average weekly manufacturing hours, etc. , weekly average number of new unemployment insurance claims, etc. some.
The purpose of these variables is to predict changes in the U.S. business cycle. The Conference Board specifically states that the LEI aims to predict “turning points in the business cycle by approximately seven months.” In other words, the National Bureau of Economic Research is trying to predict a recession before it is officially announced.
The LEI fell by 0.4% in January, marking the 22nd consecutive month of decline. This coincides with the period from 1973 to 1975 when the LEI had the second longest consecutive monthly decline when backtested to 1959. The only contraction that lasted longer was the 24-month contraction observed during the Great Recession (2007-2009).
US Conference Board LEI latest reading -7% YoY pic.twitter.com/vWtNQTskAV
— Longview Economics (@Lvieweconomics) February 20, 2024
However, it is not the monthly decline that is most worrying. Historically, one-year comparisons have proven to tell us much more about the U.S. economy.
In terms of year-over-year changes in the LEI, since 1959 the index has fallen many times, ranging from 0.1% to 3.9%. These declines should not be ignored, but simply serve as a cautionary moment for investors. This does not imply a recession in the US.
Now comes the interesting part. If the LEI declines by at least 4% year over year, it will ultimately mean that a recession has materialized in the United States. In the last 60 years, there has never been a time when the LEI has fallen by at least 4% and the United States has not fallen into recession. As of January 2024, the LEI is down 7% year-on-year.
To be fair, stock prices don’t necessarily reflect the performance of the U.S. economy. Because Wall Street tends to be forward-looking, we often see the Dow, S&P 500, and Nasdaq Composite bottom before the U.S. economy reaches a trough. Nevertheless, corporate profits typically rise and fall depending on the health of the U.S. economy. If the Conference Board LEI maintains its original stance of predicting a US recession, most would expect stocks to enter a bear market.
Wall Street is pricing for perfection (and that’s historically bad news too)
The worry for investors is that the Conference Board LEI is just one of a growing number of indicators and metrics warning of potential turbulence on Wall Street in the not-too-distant future. Coupled with the increasing likelihood of a recession due to a decline in the M2 money supply, tightening of bank lending practices, and a steepening Treasury yield curve, stocks are historically overvalued.
A valuation metric that should raise some eyebrows right now is the S&P 500’s Shiller price-to-earnings ratio (P/E), also known as the cyclically adjusted price-to-earnings ratio (CAPE ratio).
S&P 500 Shiller CAPE Ratio data by YCharts.
While a traditional P/E considers a company’s or index’s earnings per share over the past 12 months, the S&P 500’s Shiller P/E is based on the average inflation-adjusted earnings over the past 10 years. Examining 10 years of earnings history can smooth out the impact of temporary events such as the COVID-19 pandemic that temporarily distorted a company’s earnings.
When backtested through 1871, the average Shiller P/E ratio was 17.09. But for most of the past 30 years, this standard has been far exceeded. The advent of the Internet has democratized access to information and trading, which, combined with lower interest rates, has increased overall stock valuation multiples.
However, like the LEI, the Shiller P/E has an arbitrary number in the sand and has historically been problematic for investors. Specifically, this is when the Shiller P/E exceeds 30 and remains there during the upswing of a bull market.
Looking back over 150 years, there have only been six instances in which the S&P 500’s Shiller P/E exceeded 30 and remained at this level for any reasonable period of time. Following the previous five episodes, the S&P 500 and Dow Jones Industrial Average continued to lose between 20% and 89% of their value. In other words, historically, bear markets occur when valuations expand in an upward direction. As of the closing price on Thursday, February 22nd, the Shiller P/E ratio was over 34x.
To be clear, the Shiller P/E ratio for the S&P 500 is not a timing tool. This means that the valuation can be extended over a long period of time, such as the four years from 1997 to 2001. However, the lesson of history is that the extension of the appraised value Ultimate Significant declines in the Dow, S&P 500, and Nasdaq Composite.
Image source: Getty Images.
Well, good news
Given the stock market’s performance over the past 14 months, the prospect of a sharp drop in stocks is probably the last thing investors want to think about. But there is good news on multiple fronts.
On the other hand, recessions in the United States are a normal and inevitable part of the economic cycle. Since World War II ended in September 1945, the U.S. economy has survived more than a dozen contractions. But the problem is that 9 of these 12 of her depressions were in his less than a year, and the remaining 3 were in his less than 18 months. Economic downturns tend to be temporary in the grand scheme of things.
In comparison, periods of economic expansion can last for a long time. Since September 1945, the US economy has experienced two periods of growth that have reached ten years. Over the long term, the American economy will expand, and it’s a similar story for the stock market.
Since 1950, the S&P 500 index has endured 40 double-digit declines, which translates to a correction approximately once every 1.85 years. Even though we never know in advance when these declines will occur, how long they will last, or where the bottom will ultimately be, all of these double-digit declines ultimately lead to a bull market rally. History shows that it was completely restored.
It’s official. A new bull market has been confirmed.
The S&P 500 is currently up 20% from its October 12, 2022 closing low. During the last bear market, the index fell 25.4% in 282 days.
For more information, please visit https://t.co/H4p1RcpfIn. pic.twitter.com/tnRz1wdonp
— Bespoke (@bespokeinvest) June 8, 2023
A data set released by Bespoke Investment Group analysts last year confirmed just how unbalanced the bear and bull markets are on Wall Street. Since the Great Depression began in September 1929, the average S&P 500 bear market has lasted 286 calendar days, or about 9.5 months. This compares to his 1,011 calendar days in the average S&P 500 bull market over the same timeline.
If we look further back, we get even more compelling data about the power of time and patience as investors.
Each year, Crestmont Research analysts update a data set that examines the S&P 500 Index’s 20-year total return, including dividends paid. S&P was founded in 1923, but its components may be found in other areas. Primary index before creation. This allowed Crestmont to backtest his S&P total returns back to 1900, giving him 105 data over a 20-year rolling period (1919 to 2023).
The key finding is that none of the 105 20-year periods produced negative total returns. Hypothetically speaking, as long as an investor held his S&P 500 or S&P 500 tracking index stock for 20 years, he could have profited every time.
Therefore, patience and perspective are powerful tools when it comes to investing money on Wall Street.
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