In case you haven't noticed, the bulls are once again running wild on Wall Street. Following a difficult 2022 that saw the ageless Dow Jones Industrial Average (^DJI 0.40%), benchmark S&P 500 (^GSPC 1.02%), and growth-dependent Nasdaq Composite (^IXIC 2.02%), enter bear markets and respectively shed 9%, 19%, and 33% of their value by years' end, all three indexes have bounced back significantly since touching their 2022 bear market lows.
Although some investors believe that a new bull market doesn't take shape until the major indexes eclipse their old highs, a more commonly accepted definition, which states that a bull market begins when an index has rebounded 20%+ following a decline of at least 20%, suggests we're well into a new bull market for the Dow Jones, S&P 500, and Nasdaq Composite.
Image source: Getty Images.
While there's no denying the momentum we're witnessing in the major stock indexes at the moment, there is also no shortage of economic indicators and metrics that imply Wall Street isn't out of the woods. What if, instead of a brand-new bull market, we're actually in nothing more than an epic bear market rally?
Keep in mind that during the 2000-2002 dot-com bubble, the Nasdaq Composite entered multiple "new" bull markets, by the commonly accepted definition, but ultimately took out new lows every time. On a peak-to-trough basis, one of these bear market rallies surpassed 40%.
What follows are five charts that suggest we're witnessing an epic bear market rally on Wall Street.
1. U.S. money supply is meaningfully declining for the first time since the Great Depression
The first chart comes courtesy of Reventure Consulting CEO Nick Gerli, who examined the correlation between U.S. M2 money supply and the performance of the U.S. economy. M2 money supply takes into account everything in M1 (coins, cash bills, and demand deposits from checking accounts), and adds in money market funds, savings accounts, and certificates of deposit (CDs) under $100,000.
WARNING: the Money Supply is officially contracting. 📉
-- Nick Gerli (@nickgerli1) March 8, 2023
This has only happened 4 previous times in last 150 years.
Each time a Depression with double-digit unemployment rates followed. 😬 pic.twitter.com/j3FE532oac
When back-tested to 1870, M2 has had very few instances where it's declined on a year-over-year basis. That's not a surprise, given that a steadily growing U.S. economy over the long run is going to need more available capital for consumers to buy goods and services.
However, there have been four previous instances where M2 money supply declined by at least 2% from the previous year. These four instances led to three depressions (1870s, 1921, and the Great Depression), as well as one panic (1893). We're witnessing a fifth instance of M2 money supply meaningfully declining right now, with M2 4.13% below its all-time high, as of June 2023.
While it's possible that M2 is simply correcting lower after a record expansion of the U.S. money supply during the COVID-19 pandemic, it may also signal that a period of high inflation is suppressing consumer purchases. History has not been kind when M2 money supply falls by at least 2%.
2. A historic yield-curve inversion may spell trouble
The second chart that spells trouble is the Treasury bond yield curve. Specifically, we're looking at the spread (difference in yield) between the three-month and 10-year notes.
In a healthy economy, the yield curve slopes up and to the right. In other words, Treasury bonds that mature a long time from now have higher yields than those set to mature in a few months or perhaps a year or two. The longer your money is tied up, the higher the yield you should receive.
10 Year-3 Month Treasury Yield Spread data by YCharts. Gray areas denote U.S. recessions.
As you can see from the chart above, the three-month/10-year Treasury yield is at its largest inversion in more than four decades. When short-term bonds have substantially higher yields than longer-dated notes, it's typically an indication that investors see trouble ahead for the U.S. economy.
The Federal Reserve Bank of New York's recession probability tool, which uses the three-month/10-year yield spread to forecast the likelihood of U.S. recessions over the next 12 months, suggests a 67.31% chance of a recession by June 2024. Historically, stocks have a poor track record in the months following the official declaration of a recession.
3. Commercial bank lending is doing something we've only seen happen four times in 50 years
Another ominous sign can be found with U.S. commercial bank credit.
Over the past half-century, bank lending has increased steadily. With the U.S. economy growing over the long run, and banks needing to cover the expenses associated with taking in and holding customer deposits, they're incented to lend money and generate interest income.
US Commercial Banks Bank Credit data by YCharts.
What you're seeing above is a chart that shows only four instances over a 50-year period where commercial bank lending has declined by more than 1.5% from its all-time high. The previous three times banks meaningfully tightened their lending standards (1975, 2001, and 2009-2010) resulted in the benchmark S&P 500 losing in the neighborhood of half of its value.
You'll note that we're seeing the fourth occurrence right now, with U.S. commercial bank credit 1.79% below it's all-time high, set in February 2023. If banks are making it tougher to borrow, it usually represents a bad sign for corporate America.
4. New industrial orders are in rarified territory
The fourth chart that signals we may be in nothing more than a mammoth bear market rally is the U.S. ISM Manufacturing New Orders Index, which is actually a subcomponent of the more-popular U.S. ISM Manufacturing Index (also known as the Purchasing Managers Index, or PMI).
To be fair, the U.S. economy is more reliant on software and technology than ever before. Nevertheless, examining new industrial orders still provides insight into the health of the economy.
US ISM Manufacturing New Orders Index data by YCharts. Gray areas denote U.S. recessions.
The U.S. ISM Manufacturing New Orders Index is measured on a scale of 0 to 100, with 50 representing the baseline where industrial order activity is neither expanding nor contracting. A figure above 50 would signal expansion, while a number below 50 implies contraction. The ISM Manufacturing New Orders Index has been below 50 for 10 consecutive months.
What's even more noteworthy is that two of these 10 months resulted in a figure below 43.5. Over the past 70 years, anytime the U.S. ISM Manufacturing New Orders Index has fallen below 43.5, the U.S. economy fell into a recession.
5. Banks are tightening their belts on credit card loans
The fifth and final chart that suggests we're in nothing more than an epic bear market rally is the net percentage of domestic banks tightening their standards for credit card loans. This figure is reported quarterly by the Board of Governors of the Federal Reserve System.
According to the NY Fed, consumer credit card balances stood at $986 billion, as of the end of March. Although household credit card debt lags mortgage debt ($12.04 trillion), student loan debt ($1.6 trillion), and auto loan debt ($1.56 trillion) in nominal size, plastic represents a key funding source for essential and discretionary consumer purchases -- especially in an environment where the personal saving rate has declined to a near-15-year low and the U.S. inflation rate has been well above average.
US Net Percentage of Banks Reporting Tightening Standards for Credit Card Loans data by YCharts. Gray areas denote U.S. recessions.
On a year-over-year basis, as of March 31, 2023, serious delinquencies (90 days or more delinquent) were up across all household debt and credit categories, save for student loans. Serious delinquencies among credit card debtholders surged 50%, from 3.04% to 4.57%, which means more and more credit card debtholders aren't paying their bills.
Not surprisingly, we're seeing a significant percentage of banks tightening their lending standards on credit card loans. While substantive tightening has led to false indications of trouble in the past, such as in 1996-1997, the 30.4% of domestic banks tightening their standards for credit card loans is the highest it's been since the Great Recession, if you excluded the economic "hiccup" created by the COVID-19 pandemic.
There's one more chart you should see...
Based on the historic correlations observed in these five charts, declaring the Dow Jones, S&P 500, and Nasdaq Composite to be in a new bull market may be premature.
Then again, debating the merits of what defines the beginning or end of a bull or bear market doesn't matter much if you have a long-term mindset. Here's another chart that investors should familiarize themselves with:
What you see above is a chart of the broad-based S&P 500 since the start of 1950. It's full of double-digit percentage corrections -- 39 of them, to be exact -- and instances where investors thought a wall or worry would cave in on Wall Street. Yet every single time, with the exception of the 2022 bear market (thus far), the S&P 500 has eventually whisked away these concerns and marched to new all-time highs. It's the same story for the Dow Jones Industrial Average and Nasdaq Composite.
If you invest in great businesses and allow time to work in your favor, bear markets will have minimal impact on your financial well-being.
