Over long periods, Wall Street's major stock indexes point decisively higher. But when they're examined over short periods, such as months or even a year or two, the directional movements in the Dow Jones Industrial Average (^DJI 0.40%), S&P 500 (^GSPC 1.02%), and Nasdaq Composite (^IXIC 2.02%) become far less predictable.
For example, the Dow Jones, S&P 500, and Nasdaq Composite pushed to multiple record-closing highs in 2021. This was followed in 2022 by all three indexes plunging into a bear market and producing their worst full-year returns since the financial crisis. Meanwhile, through the first five months and change of 2023, it's been a running of the bulls once more for megacap growth stocks.
Image source: Getty Images.
When Wall Street gets whipsawed, investors often look for clues from various indicators and metrics as to where stocks will head next. At the moment, one of the U.S. economy's most old-school indicators looks to be signaling trouble for Wall Street, and therefore the stock market.
This boring indicator often speaks volumes about the U.S. economy and Wall Street
For months, I've offered takes that show how history does not repeat itself, but it often rhymes on Wall Street. I've looked at an assortment of valuation metrics, lending and money supply datasets, and recession-probability indicators, to make educated guesses as to where stocks will head next.
But sometimes, it's just easiest to think inside the box. I'm talking about one of Wall Street's most old-school economic indicators: corrugated box shipments.
I admit that the phrase "corrugated box shipments" is enough to put a five-cup coffee drinker to sleep on the spot. Nevertheless, goods are regularly shipped in cardboard boxes, which can act as a leading indicator to the health of the U.S. economy.
Cardboard box recession.https://t.co/mxwmAnpbt5 pic.twitter.com/pzUEOJYbI1
-- Tracy Alloway (@tracyalloway) June 6, 2023
As you can see in this tweet, which was shared by Tracy Alloway, the co-host of the Odd Lots podcast on Bloomberg, industry shipments of corrugated boxes have fallen considerably, on a year-over-year basis, since the beginning of 2022.
Although the U.S. economy is more reliant on technology than ever before -- insert artificial intelligence-driven multitrillion-dollar spending forecast here -- businesses from all sectors and industries still rely on cardboard boxes to ship and receive goods. If we're seeing a discernible drop-off in cardboard box shipments, it would imply that fewer goods are being shipped and/or ordered.
The last time we witnessed a double-digit percentage decline in cardboard box shipments was the financial crisis in 2008-2009. The current drop in corrugated box shipments is also on par with the dip observed in 2001, when the dot-com bubble burst. During the financial crisis and dot-com bubble, the S&P 500 ultimately shed 57% and 49% of its value, respectively.
If history chooses to rhyme, once more, with this boring indicator, Wall Street and the stock market should be prepared for a recession.
The U.S. economy isn't out of the woods
On one hand, the U.S. economy has proven exceptionally resilient in the face of historically high inflation and 500 basis points of federal funds rate hikes since March 2022.
For instance, job creation has consistently outpaced forecasts for more than a year. As a result, the U.S. unemployment rate remains well below 4%. During periods of economic turmoil, the unemployment rate will rise, which isn't happening at the moment.
But in spite of strong job creation and pockets of strength throughout various sectors and industries of the economy, other indicators would suggest the U.S. economy isn't out of the woods.
10 Year-3 Month Treasury Yield Spread data by YCharts. Gray areas denote U.S. recessions.
For example, the Federal Reserve Bank of New York's recession-probability tool is practically yelling at the top of its proverbial lungs that an economic downturn is likely. The NY Fed's recession indicator measures the spread (difference in yield) between the three-month and 10-year Treasury bond to gauge how likely it is a U.S. recession will crop up over the next 12 months.
In a healthy economy, the Treasury bond yield curve slopes up and to the right. In other words, bonds that mature in 10 or 30 years have higher yields than those maturing in three months or one year from now. You should be compensated with a higher yield if your money is being tied up for a longer period.
Right now, the Treasury bond yield curve is deeply inverted. Short-term notes have substantially higher yields than longer-maturing bonds, which is a signal that investors believe economic trouble is ahead. As of April, the NY Fed's recession tool is forecasting a 70.85% chance of an economic downturn within 12 months. That's the highest probability of a recession from this indicator since 1981.
Even the Federal Reserve itself has a cautionary tale about the U.S. economy.
The minutes from the Federal Open Market Committee's March meeting show that the 12-member body responsible for monetary policy decisions has incorporated a "mild recession" into its outlook for later this year. With few exceptions, aggressive rate-hiking cycles have a history of pushing the U.S. economy into a recession.
The reason I've spent so much time discussing the possibility of a U.S. recession is because recessions are bad news for stocks, at least for a couple of months/quarters. History has shown that the bulk of stock market losses occur after, not prior to, the official declaration of a recession by the eight-economist panel at the National Bureau of Economic Research. If a recession does materialize, it wouldn't be a surprise to see stocks notably pull back.
Image source: Getty Images.
Long-term thinking has a way of paying off for investors
While this data about cardboard boxes and predictions from the Fed might be unnerving, it's important to add time to the equation.
As noted, the stock market is highly unpredictable over the short run. Though there are numerous indicators, metrics, and datasets that have strong track records of predicting the directional movement in stocks, none is guaranteed to be 100% accurate. If you want to truly give yourself the best chance to build wealth on Wall Street, all you have to do is think long term and be patient.
I'll freely admit that being patient when the Dow, S&P 500, and Nasdaq Composite are swinging up and down by 2% or 3% daily can, at times, be difficult. But pan out a bit, and you'll see a far different story.
As an example, the Black Monday crash in 1987 sent the iconic Dow Jones Industrial Average screaming lower by 22.6%. It's widely considered one of Wall Street's darkest days. Yet if you pan out the chart for the ageless Dow Jones over a more than eight-decade stretch, this historic crash is a hardly visible blip.
Stock market corrections, bear markets, and even crashes are a normal part of the long-term investing cycle, just as recessions are an inevitability of the economic cycle. But just as the U.S. economy spends a disproportionate amount of time expanding as opposed to contracting, the Dow, S&P 500, and Nasdaq all spend far more time in a bull market than in a bear market.
Patience has continually paid off for long-term investors, and that's not going to change no matter what the next 12 months holds in store for the U.S. economy or Wall Street. While it might pay to have some cash at the ready to invest if stocks do decline, staying the course and owning high-quality companies is the formula that continues to pay off.
