Over long stretches, Wall Street has proven to be nothing short of a money machine. The stock market has handily outpaced the annualized returns of bank certificates of deposit (CDs), housing, oil, gold, and Treasury bonds over the long run.

But when examined over short periods, the stock market can be something of a crapshoot. Take 2022 as an example. Following up one of the strongest years in recent memory in 2021, the widely followed Dow Jones Industrial Average (^DJI -0.83%), benchmark S&P 500 (^GSPC -0.33%), and technology-dependent Nasdaq Composite (^IXIC -0.48%) all plunged into a bear market and produced their worst full-year returns since the financial crisis.

Although 2023 has started off with a bang -- especially for large-cap tech stocks -- one leading economic indicator offers an ominous warning for Wall Street and investors.

A magnifying glass laid atop a financial newspaper, with two words enlarged that read, Market data.

Image source: Getty Images.

It's unlucky No. 13 for Wall Street

Before digging into the specifics, a word of caution: No economic indicator or metric is foolproof. While some have undeniably strong track records of calling the directional movement in stocks and/or predicting economic downturns in the U.S. economy, nothing can be written in stone on Wall Street.

With that being said, one economic indicator with 64 years of history under its belt has, under certain circumstances, correctly predicted an economic downturn without ever being wrong. This metric in question is the Conference Board Leading Economic Index (LEI).

The LEI, as it's more commonly known, is comprised of 10 leading economic inputs. A few of these inputs are financial in nature, such as the interest rate spread of 10-year Treasury bonds less the federal funds rate. But most of the LEI's components are nonfinancial, such as private housing building permits, average weekly initial unemployment insurance claims, and the ISM Index of New Orders, to name a few. These inputs are designed to anticipate a shift in the business cycle by roughly seven months. 

Further, the LEI is measured on a rolling six-month annualized basis and compared to the same period one year prior. Although there have been a number of instances where the LEI has turned slightly negative since 1959, investors have been able to draw a definitive line in the sand anytime the Conference Board LEI declines by at least 4% from the comparable period in the previous year.

Over the past 64 years, there hasn't been a single instance where the LEI fell by at least 4% and a recession didn't materialize. As of December 2022, the LEI had dropped by 4.2% from the prior-year period.

Furthermore, Liz Ann Sonders, the Chief Investment Strategist at Charles Schwab, noted in the above tweet that the LEI recently declined for a 13th consecutive month. 

In addition to the number 13 carrying some unlucky and superstitious connotations, a 13th straight month of declines represents the third-longest stretch in the LEI's 64-year history. Only the 22-month and 24-month drops in the LEI beginning in 1973 and 2007, respectively, lasted longer. For context, the S&P 500 shed 48% of its value in 1973 and 57% of its value in 2007. Though past performance is no guarantee of future results, this sure looks like unlucky No. 13 for Wall Street.

Recessions and the stock market don't mix (at least if you're a short-term investor)

The broad implication of what the LEI is signaling is that the U.S. economy is steering toward a recession. When economic growth slows down and shifts into reverse, it tends to hit most sectors and industries. For corporate America, it's rarely good news -- and that's typically reflected in stock prices.

For instance, Chief U.S. Strategist Ed Clissold of independent research firm Ned Davis Research examined what, if any, correlation exists between bear markets and the start and end of official U.S. recessions ("official" in the sense that they're declared by the eight-economist panel of the National Bureau of Economic Research). Clissold analyzed 12 bear markets after World War II, as you can see in his tweet below.

The interesting takeaway is that no bear market after 1945 has found its bottom prior to the official start of a U.S. recession.

What's meaningful about Clissold's analysis is that the Federal Reserve is also onboard with the idea of economic weakness materializing. The minutes from the Federal Open Market Committee's March meeting noted that a mild recession had been built into its outlook for later this year. If this assessment proves accurate, the Dow Jones, S&P 500, and Nasdaq Composite, despite their relatively strong performance thus far in 2023, may not have seen their bear market lows just yet.

Furthermore, the nation's central bank doesn't exactly have the best track record when raising rates and avoiding a recession. Over a 68-year period, there have been 13 clearly defined rate-hiking cycles. Not including the current cycle, 10 of the previous 12 have resulted in a U.S. recession. Every rate-hiking cycle topping a total federal funds rate increase of 3.1% has led to a recession after World War II.

Recessions have historically not boded well for stocks in the short run.

A smiling person looking out a window while holding a financial newspaper in their hands.

Image source: Getty Images.

For long-term investors, recessions can be blessings in disguise

From an economic standpoint, recessions aren't enjoyable events. They often lead to rising unemployment and reduce the wage-bargaining power of workers.

However, recessions also tend to be short-lived. As you'll note from Clissold's tweet, every recession after World War II has lasted just two to 18 months. That compares to economic expansions, which often go on for years.

But for long-term investors who have cash at the ready, recessions can be blessings in disguise.

Since the start of 1950, data from sell-side consultancy firm Yardeni Research shows that there have been 39 double-digit percentage declines in the broad-based S&P 500. On average, that's a drop of at least 10% every 1.9 years.

Yet, despite never knowing when a downturn will begin, how long it'll last, or how steep the ultimate drop will be, the Dow, S&P 500, and Nasdaq have continually erased the losses tied to corrections and bear markets throughout history. If you buy high-quality stocks or index funds during a correction or bear market, there's a good chance you'll be able to benefit from the subsequent rebound.

To add to this point, timing is far less important than you might realize if you're a long-term investor. Based on a report from market analysis company Crestmont Research, if you hypothetically purchased an S&P 500 tracking index at any point since 1900 and held that position for 20 years, you made money. Including dividends, the median 20-year rolling return, including dividends, covering 104 ending years (1919 through 2022) was around 9%. This is a rate of return that can double your money, with reinvestment, in just eight years.

Regardless of what the Conference Board LEI suggests is coming for the U.S. economy, and what recessions have, historically, done to stocks in the short term, long-term investors find themselves in an excellent position to capitalize on any weakness.