Volatility is an expectation when investors put their money to work on Wall Street. However, the vacillations in the ageless Dow Jones Industrial Average (^DJI +0.72%), benchmark S&P 500 (^GSPC +0.22%), and growth-powered Nasdaq Composite (^IXIC +0.20%) have been otherworldly since the beginning of 2020.
In 2020, the COVID-19 pandemic plunged all three indexes into a bear market at the fastest pace in history. Though the 2022 bear market was more orderly, it still left the Nasdaq Composite staring down a 33% decline. Meanwhile, access to historically cheap capital and ongoing fiscal stimulus created a level of investor euphoria that sent the Dow, S&P 500, and Nasdaq Composite catapulting to new highs in 2021.
After such wild swings on Wall Street, investors want one simple question answered: What's next for the stock market?
Image source: Getty Images.
Although there's no such thing as a foolproof indicator or predictive tool that can tell investors what's going to happen with the U.S. economy or Wall Street with 100% accuracy, there are metrics that offer historically strong correlations to moves in the broader market. Right now, one prominent economic indicator is making history -- but for all the wrong reasons.
This has only happened three times in 75 years
To be fair, it's easy for investors to be overwhelmed by the sheer amount of economic data that's released each week, month, or quarter. But one report that tends to catch the eye of most economists is the monthly released ISM Manufacturing New Orders Index. This is a component of the even more popular ISM Manufacturing Index, which is also known as the Purchasing Managers' Index.
The ISM Manufacturing New Orders Index is a survey-based indicator that examines new industrial order activity. This survey asks respondents to compare new industrial order activity to the previous month and includes a subjective component that asks respondents to answer whether they believe industrial order output will be higher or lower in 12 months.
Although the U.S. has become increasingly reliant on software and technology over time, industrial orders have historically been a strong predictor of U.S. economic growth or contraction, which ultimately dictates what happens with corporate earnings.
The ISM Manufacturing New Orders Index is measured on a scale of 0 to 100, with 50 representing a neutral baseline where new industrial orders are neither expanding nor contracting. A figure above 50 implies new orders are expanding, while a number below 50 denotes a contraction in industrial orders.
The ISM manufacturing index has now spent 12 consecutive months below 50 (i.e. contraction territory). The only times this has been surpassed were '81-'82 & '08-'09. pic.twitter.com/rml6AqsQHF
-- Longview Economics (@Lvieweconomics) September 1, 2023
The ISM Manufacturing New Orders Index came in at a reading of 46.8 for August 2023. This is a level that signals weakness for new industrial orders.
However, the bigger story is that August marked the 12th consecutive month of contraction for the ISM Manufacturing New Orders Index. There have only been three instances in the 75 years (since 1948) that this index has been reported where we've witnessed a full year or longer of readings below 50. The only two other instances were in 1981-1982 (18 months) and 2008-2009 (14 months).
Furthermore, every instance where the ISM Manufacturing New Orders Index came in below 50 for at least a nine-month stretch has resulted in the U.S. economy falling into a recession. Based strictly on historical precedent, this index is telling investors that a U.S. recession is coming.
How does that relate to the stock market? Although stocks aren't tied at the hip to the performance of the U.S. economy, equities have a pretty poor track record in the months following the official declaration of a recession by the eight-economist panel at the National Bureau of Economic Research. Approximately two-thirds of the S&P 500's peak-to-trough declines occur during a recession and not prior to one being declared. In other words, if history repeats itself, the stock market could head lower in the not-too-distant future.
Image source: Getty Images.
Wall Street is a numbers game that favors the patient
Considering how strongly the S&P 500 and Nasdaq Composite have rallied in 2023, this may not be the prediction you wanted to hear. However, your investment horizon is a far more important puzzle piece to the wealth-building equation on Wall Street.
In general, recessions are no fun. They often result in job losses and reduced wage growth for workers, as well as weaker corporate earnings. But what's regularly overlooked about downturns in the U.S. economy is that they're perfectly normal and (key point!) short-lived.
Since World War II ended, the U.S. economy has navigated 12 recessions. Each of these downturns has lasted between two and 18 months.
While there have been a couple of expansions that have been relatively short, most periods of economic growth have been measured in multiple years, if not a full decade. Even if history proves accurate once more and the U.S. economy dips into a recession later this year or in the first-half of 2024, the expectation would be for only a short period of turbulence.
Interestingly enough, this disproportionate battle between positivity and negativity play out on Wall Street.
It's official. A new bull market is confirmed.
-- Bespoke (@bespokeinvest) June 8, 2023
The S&P 500 is now up 20% from its 10/12/22 closing low. The prior bear market saw the index fall 25.4% over 282 days.
Read more at https://t.co/H4p1RcpfIn. pic.twitter.com/tnRz1wdonp
A few months ago, wealth management company Bespoke Investment Group analyzed the average length of bull and bear markets in the S&P 500, dating back to September 1929. Bespoke's definition of a bull market entails a 20% (or greater) rally following a 20% (or greater) decline, while a bear market is the inverse -- a 20%+ decline following a 20+ rally. By this definition, Bespoke examined 27 separate bull and bear markets.
According to the company, the average bear market over the past 94 years has lasted 286 calendar days. By comparison, the typical bull market since September 1929 has continued for 1,011 calendar days. Put in context, the average bull market is 3.5x longer than the average bear market.
Are skeptics going to be right about the U.S. economy and stock market over the short run? Quite possibly. But if you're an optimist with a long-term mindset, the numbers game is very much in your favor.
