Over the long term, Wall Street has proven to be a true wealth creator. Other asset classes, such as bonds and homes, have enriched investors, but none have come close to the average annual returns that stocks have generated for over a century.
Wall Street is currently experiencing a bull market again. Since the green flag was waved in early 2023, Dow Jones Industrial Average (DJINDICES: ^DJI)standard S&P 500 (SNPINDEX: ^GSPC)and driving growth Nasdaq Composite Index (NASDAQINDEX: ^IXIC) As of the closing price on June 27, 2024, these have increased by 18%, 43%, and 71%, respectively.
But if there’s one thing that’s certain on Wall Street, it’s that stocks don’t move up in a straight line. While artificial intelligence and a frenzy over stock splits are fueling the current bull market, three predictors that have a historically strong correlation with Wall Street declines appear to be heralding a possible stock market crash in 2024.
Historic decline in US M2 money supply
To be clear, there is no indicator that can predict the short-term direction of the major stock indexes with any degree of accuracy. However, certain indicators have historically had the ability to predict declines in the Dow Jones, S&P 500, and Nasdaq Composite Index. The US M2 Money Supply is one such indicator.
The M2 money supply is made up of everything in M1 (cash and coin in circulation and current deposits in checking accounts), plus money market accounts, savings accounts, and certificates of deposits (CDs) under $100,000. Think of M1 as money that you can easily spend, and M2 as money that is relatively easy to spend, but that requires more work to obtain.
For 90 years, the M2 money supply has been expanding virtually uninterrupted — in other words, more capital needed to be put into circulation to support a growing economy.
WARNING: The Money Supply is Officially Contracting. 📉
This has only happened four times in the past 150 years.
Each time, a major depression followed, with unemployment reaching double digits. pic.twitter.com/j3FE532oac
— Nick Gerli (@nickgerli1) March 8, 2023
However, since peaking in April 2022, M2 has declined significantly. Despite being up 0.69% year-over-year, the US M2 money supply is down a total of 3.49% from its all-time high. As Reventure Consulting CEO Nick Gerli explains in an X post, this is only the fifth time since 1870 (backtested) that M2 has fallen 2% or more year-over-year (1878, 1893, 1921, 1931-1933, 2023).
The last four instances of M2 declines of 2% or more have correlated with periods of double digit unemployment and economic recessions. Two of these instances occurred before the creation of the Federal Reserve and a recession is highly unlikely today, but the bottom line is that less capital in circulation means less discretionary consumer purchases, which is a recipe for recessions and historically, stock markets have tanked when a recession is declared.
The longest yield curve inversion in modern times
The second predictive tool for warning of trouble on Wall Street is the Treasury Yield Curve, which is a much more popular indicator compared to the M2 Money Supply.
Treasury yield curves are typically upward sloping, which means that longer-term Treasury bonds (those maturing in 10 or 30 years) offer higher yields than shorter-term Treasury bills that mature in a year or less. The longer you park your money in an interest-earning asset, the higher your yield should be.
Since July 5, 2022, the spread between 10-year and 2-year Treasury notes has been negative. In other words, the yield on 2-year Treasury notes is higher than the yield on 10-year Treasury notes. This is the so-called yield curve inversion, and the longest inversion in modern history.
What’s interesting about yield curve inversions is that they have preceded every U.S. economic downturn since the end of World War II: roughly two-thirds of the S&P 500’s peak-to-trough declines have occurred during U.S. recessions.
But this big However, not all yield curve inversions lead to a recession. We consider yield curve inversions a necessary indicator that the U.S. economy is facing headwinds.
The stock price is abnormally high
A third predictive indicator that may signal a stock market crash is on the way is the valuation-based Shiller price-earnings ratio (P/E), also commonly referred to as the cyclically adjusted price-earnings ratio (CAPE).
While traditional P/E ratios focus on earnings over the past 12 months, the Shiller P/E for the S&P 500 is based on an average of inflation-adjusted earnings over the past 10 years. Looking at a 10-year earnings history mitigates “stumbling blocks” (e.g., the impact of COVID-19) that could distort investors’ perception of value.
As of the close of trading on June 27, the S&P 500’s Shiller P/E ratio was 35.70. For reference, that’s more than double the 17.13 average over the past 153 years of backtesting.
What’s interesting about the Shiller P/E is looking at how major Wall Street stock indexes have reacted during bull markets when the Shiller P/E has risen above 30. This has happened six times since 1871: 1) August 1929-September 1929, 2) June 1997-August 2001, 3) September 2017-November 2018, 4) December 2019-February 2020, 5) August 2020-May 2022, and 6) November 2023-present.
The last five instances when the Shiller P/E ratio exceeded 30 ultimately led to a decline in the value of the Dow Jones Industrial Average, the S&P 500, and/or the Nasdaq Composite Index of between 20% and 89%.
As you can see from the dates in these six examples, there is no justification for the high stock price periods. What is clear is that valuations do not hold up over the long term. When the S&P 500’s Shiller P/E ratio exceeds 30 for any sustained period of time, it has historically been a warning of a bear market and potential crash waiting to happen.
Time and perspective change everything
To reiterate, the three predictive indicators above suggest that the ingredients for a possible stock market crash in 2024 are there. However, these indicators are not a guarantee. It is impossible to specifically predict what stock prices will be in a week, month, or even a year.
But if investors take a step back and broaden their perspective, it becomes much easier to predict where stock prices are headed overall.
Take the economic cycle as a good example: no matter how much workers hate economic slowdowns and recessions, the fact remains that they are entirely normal, and no matter how much we wish for them, we cannot stop them from happening.
But these boom and bust cycles are not linear. Since World War II ended in September 1945, nine of the 12 U.S. recessions lasted less than a year, and the remaining three lasted less than 18 months. By comparison, most of the periods of economic growth lasted for several years, and two lasted more than a decade. Being optimistic and betting on an expansion in the U.S. economy has undoubtedly been a wise move.
The same dynamic is at play on Wall Street.
In June 2023, Bespoke Investment Group published the above post on X, which highlighted the calendar day length of every S&P 500 bear and bull market going back to the start of the Great Depression in September 1929. Of note, the average duration of an S&P 500 bull market (1,011 calendar days) is roughly 3.5 times longer than a typical S&P 500 bear market (286 calendar days).
Moreover, nearly half of the S&P 500 bull markets (13 out of 27) have lasted longer than the longest bear market, which lasted 94 years.
Crestmont Research Investment Advisor’s massive data set adds value in terms of time and perspective: Crestmont analysts calculated the cumulative 20-year total returns, including dividends, for the S&P 500 when tested going back to 1900. The study yielded 105 cumulative 20-year periods (1919-2023).
What this data set showed was that in all 105 20-year periods, the annual total return would have been positive. In simple terms, if you had bought the S&P 500 tracking index at any point since 1900 and held that position for 20 years, you would have made a profit every time, without fail.
No matter how dire the data and short-term forecasts may seem, time and perspective will not discourage investors.
Don’t miss out on this second chance to potentially make a profit.
Have you ever felt like you missed out on the opportunity to buy the most successful stocks? Then listen to this.
In rare cases, our team of expert analysts “Double Down” stock We recommend companies that are on the verge of collapse. If you’re worried you might have missed out on an investment opportunity, now is the best time to buy before it’s too late. The numbers speak for themselves.
-
Amazon: If you had invested $1,000 when it doubled in 2010 That works out to $21,765.!*
-
apple: If you had invested $1,000 when it doubled in 2008 That works out to $39,798.!*
-
Netflix: If you had invested $1,000 when it doubled in 2004 That works out to $363,957.!*
We currently have “Double Down” alerts on three great companies, but we may not have another opportunity like this in the near future.
See the 3 “Double Down” stocks »
*Stock Advisor returns as of June 24, 2024
Sean Williams has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
Stock market crash in 2024? 3 predictive indicators that suggest a big drop in stock prices is on the way was originally published by The Motley Fool.
