Pardon the cliché, but one of the few certainties investors can look forward to on Wall Street is uncertainty. Whereas the iconic Dow Jones Industrial Average (^DJI 0.06%), widely followed S&P 500 (^GSPC -0.22%), and innovation-driven Nasdaq Composite (^IXIC -0.52%) have a rich history of pushing higher over long periods, the directional movement of stocks over shorter timelines is completely unpredictable.
For instance, the Dow Jones, S&P 500, and Nasdaq Composite were mostly unstoppable in 2021, with all three indexes marching to multiple all-time highs. In 2022, it was the exact opposite, with all three indexes falling into a bear market and delivering their worst full-year returns since 2008.
Image source: Getty Images.
While I'd love to tell you that there are surefire indicators or metrics capable of predicting where stocks are headed next, no such concrete forecasting tool exists. There are, however, indicators and metrics that have phenomenally strong track records of forecasting directional moves for stocks over extended periods. One such indicator, which happens to have a flawless track record over the past 73 years, has a very clear message for where stocks are headed.
Given certain circumstances, this indicator has been flawless for 73 years
The past year has been filled with contradicting datasets. On one hand, job creation continues to come in well-ahead of expectations. Furthermore, first-quarter earnings growth for the S&P's 500 components was, collectively, much better than expected. Data like this suggests near-term concerns about an ongoing bear market or recession are overblown.
On the other hand, the Federal Reserve has increased the federal funds rate by 500 basis points in a little over a year. The magnitude of this increase in such a short time frame has historically boded poorly for stocks and typically pushed the U.S. economy into a recession.
But according to one indicator, which hasn't been wrong since the start of 1950, there's only one direction the stock market is headed: Up.
Today is the 100th trading day of the year.
-- Ryan Detrick, CMT (@RyanDetrick) May 25, 2023
S&P 500 up more than 7% YTD as of now and this would be the best start to a yr since 2021 and 2019 before that.
When >7% on day 100? Rest of yr up another 9.4% on avg and higher nearly 89% of time. pic.twitter.com/Sl5tFaXPkM
As you can see in the tweet above by Carson Group's Chief Marketing Strategist Ryan Detrick, the benchmark S&P 500 has a flawless track record of staying green when it's been higher by at least 7% on the 100th trading day of the year. In fact, it's averaged a better-than 23% return for the full year when up by no less than 7% on the 100th trading day.
As for the return of the S&P 500 after this line-in-the-sand 100th trading day, it's pretty green as well. In 23 out of 26 years, the S&P 500 delivered additional gains after this arbitrary cutoff, with an average return of 9.4%. This year (2023) marks the 27th time since the start of 1950 that the S&P 500 has delivered a strong start.
Keep in mind that this isn't the first time Detrick has sounded the horn on a bullish stock market indicator. Less than three weeks ago, he noted that the widely followed Nasdaq 100 -- an index comprised of the 100 largest nonfinancial companies listed on the Nasdaq exchange -- was higher one year later 14 out of 14 times when it had gone at least six months without notching a new 52-week high. The 15th occurrence of this event was May 18, 2023.
If these flawless datasets could speak, they'd tell investors that a new bull market has established itself.
Here's where things get interesting...
There's no question that an indicator with 73 years of flawless predictive history to back it up has some weight. But it's certainly not the only indicator or metric with a strong track record of predicting where the U.S. economy or stocks are headed next.
For example, the Federal Reserve Bank of New York's recession-probability tool has a pretty clear message of its own of what's to come.
10 Year-3 Month Treasury Yield Spread data by YCharts. Gray areas denote U.S. recessions.
The New York Fed's recession-probability indicator analyzes the spread (i.e., difference in yield) between the three-month and 10-year Treasury bonds to determine how likely it is that a recession will materialize in the coming 12 months. Whereas the yield curve normally slopes up and to the right, with bonds maturing many years from now sporting higher yields than short-term notes, the yield curve is currently inverted. In other words, short-term bonds have higher yields than longer-term Treasury bonds. This typically occurs when investors are worried about the near-term economic outlook.
According to the New York Fed, the probability of a recession within the next 12 months hit 68.22% in April. That's the highest reading in more than 40 years. Furthermore, the New York Fed's recession-probability tool hasn't been wrong in 57 years if the probability of a U.S. recession surpasses 40%.
Statistically speaking, most of the losses the Dow, S&P 500, and Nasdaq endure occur after, not prior to, an official recession being declared.
Likewise, the contraction we're witnessing in M2 money supply is also ominous.
Looking back 153 years, there have only been five instances when M2 money supply -- cash, coins, savings accounts, money market funds, and certificates of deposit of less than $100,000 -- has contracted by at least 2%. The previous four instances, which all occurred between the 1870s and 1933, led to three depressions and a panic. The fifth instance is ongoing, with M2 4.8% below its record high set last summer.
The concern with a contraction in M2 is that there's less money in circulation to cover expenses in an environment where inflation is higher than normal. Declining money supply with an above-average inflation rate is often a recipe for an economic downturn.
Image source: Getty Images.
Take the long road and ignore the short-term noise
With extensive track records on both sides of the aisle, investors are left to wonder which indicators and metrics will prove accurate. But if investors take a step back and look at the big picture, worrying about which side will prevail tends to be pointless.
Over the past 73 years, there have been 39 instances documented by sell-side consultancy firm Yardeni Research when the S&P 500 endured a double-digit percentage correction. On average, sizable declines occur on Wall Street about every 1.9 years. They're quite common, as much as the velocity of downside moves may come as a surprise to investors.
But what's been foolproof over these seven-plus decades is the Dow Jones Industrial Average, S&P 500, and Nasdaq Composite eventually recouping their point-based losses. Although it's impossible to know the start and end dates of a correction ahead of time, or how much the indexes will decline, we do know that bull market rallies eventually wipe away corrections and bear market declines. Patience is the only thing needed from investors to accomplish this feat.
^SPX data by YCharts. Gray areas denote U.S. recessions.
If we look back even further, it's the same story. Market research company Crestmont Research examined what the total returns, including dividends, would be for an investor who, hypothetically, purchased an S&P 500 tracking index and held that position for 20 years. Since most indexes contain many of the same companies, Crestmont was able to backtest its data to 1900, which left it with 104 ending years of rolling 20-year return data (1919 to 2022).
The closest thing to a guarantee you'll get on Wall Street is an increase in the S&P 500 over a 20-year stretch. Inclusive of dividends, all 104 ending years would have produced a positive total return. The clear takeaway is that it doesn't matter when you put your money to work on Wall Street as long as you're willing to be patient and allow your investment theses to play out.
It's possible Detrick could be spot on and a new bull market has taken shape. It's also feasible we're witnessing a rally during an extended bear market. Ultimately, the answer doesn't matter if you have a long-term mindset and continue to allow time to be your ally.
