For well over a century, the stock market has outpaced all other asset classes. Even accounting for down years, the annualized returns of the broader market have handily outpaced the annualized returns of Treasury bonds, housing, gold, oil, and pretty much any other asset class you can think of.
But it's a completely different story if the lens is narrowed. Since this decade began, the ageless Dow Jones Industrial Average (^DJI 0.40%), widely followed S&P 500 (^GSPC 1.02%), and growth-stock fueled Nasdaq Composite (^IXIC 2.02%) have traded off between bull and bear markets in successive years.
In 2023, investors are smiling once again because the Dow, S&P 500, and Nasdaq have meaningfully rallied off their 2022 bear market lows. But this rally might come to an abrupt halt once the curtain closes on the current year.
Image source: Getty Images.
Though a handful of forecasting tools and widely followed metrics point to trouble to come for the U.S. economy and stock market, there's a single money-based data point that's most telling and suggests a bear market could arise in 2024.
This money-focused metric strongly suggests a bear market is coming
Although the first meaningful decline in the M2 money supply since the Great Depression stands out like a sore thumb, this isn't the money-based data point that should be raising investors' eyebrows. That dubious honor belongs to U.S. commercial bank credit.
Commercial bank credit is reported weekly by the board of governors of the Federal Reserve System, and it encompasses aggregate loans, leases, and securities (e.g., mortgage-backed securities) held by U.S. commercial banks.
Bank lending is expected to steadily increase over time. Since deposits are liabilities -- banks often have to pay interest on the deposits they take in, as well as cover in-branch labor costs -- lending to consumers and businesses is how commercial banks more than offset these expenses. Not surprisingly, commercial bank credit has climbed from an aggregate of $567 billion in January 1973 to $17.23 trillion as of Nov. 15, 2023. That's a compound annual growth rate of about 7%.
What's of interest is what happens during the rare instances when commercial bank credit declines from an all-time high. Although small blips lower of less than 2% have occurred numerous times dating back 50 years, there have only been three instances since data collection began in 1973 when commercial bank credit fell by more than 2%.
US commercial banks bank credit, data by YCharts.
As you can see in the chart above, commercial bank credit has retraced 2.07% since hitting an all-time high in mid-February. There have been only two other instances over the past half-century when a larger decline in commercial bank credit was observed:
- A maximum decline of 2.09% during the dot-com bubble in October 2001.
- A peak drop of 6.94% immediately after the Great Recession in March 2010.
A rare but sizable drop in commercial bank lending has one extremely important implication: It signifies that banks are tightening their lending standards. Though lending institutions still want to cover the costs associated with taking in deposits, they're purposely being more critical of what consumers and businesses they're lending their money to.
Though a 2.07% aggregate decline in loans, leases, and securities held by banks doesn't sound like a lot on a nominal basis, it's a big deal when you also consider that the federal funds rate has rocketed higher by 525 basis points since March 2022. Not only has access to cheap capital all but disappeared, but banks are also far less willing to lend their money. Historically, this is a recipe for slower economic growth, if not a full-blown recession.
While the stock market and the U.S. economy aren't tied at the hip, corporate earnings and long-term investor sentiment are typically dependent on the needle pointing higher for the U.S. economy. If a recession were to arise, corporate earnings would decline and stocks would very likely fall.
Since the start of the Great Depression in 1929, the S&P 500 has undergone approximately two-thirds of its drawdowns in the year following the official declaration of a recession.
The prior two times commercial bank lending declined by at least 2%, the benchmark S&P 500 shed 49% and 57% of its value, respectively, with the Nasdaq Composite hit even harder. There appear to be bountiful warning signs that a bear market could be on tap in 2024.
Image source: Getty Images.
Patience is a virtue when investing on Wall Street
It can be tough for investors to be emotionally detached when their portfolios are a sea of red ink. Bear market declines of 20% or greater tend to be especially painful for short-term traders. But for level-headed investors with a long-term horizon, these bouts of volatility for the U.S. economy and the stock market represent opportunity.
As much as investors might dislike recessions, they're a perfectly normal part of the economic cycle. What's particularly noteworthy is that only three of the 12 recessions following the end of World War II have lasted at least one year, and none of the remaining three surpassed 18 months. Compare that to periods of expansion, which typically last multiple years.
This favorable imbalance between an expanding and contracting U.S. economy is seen on Wall Street, as well.
Nearly six months ago, investment analysis company Bespoke Investment Group published a data set that looked at the average length of bull and bear markets for the S&P 500 since the start of the Great Depression (in September 1929). What Bespoke's research showed is that while the average S&P 500 bear market has lasted 286 calendar days, the 27 S&P 500 bull markets over the past 94 years have stuck around for an average of 1,011 calendar days. That's more than 3.5 times as long as the typical bear market, for those of you keeping score at home.
But if you really want to see the power of patience in action, look no further than an analysis provided by Bank of America Global Research in recent months.
Data source: Bank of America Global Research. Chart by author.
The analysts at BofA Global Research determined the probability of an investor generating negative returns in the S&P 500, in relation to the S&P 500's total returns (including dividends), dating back to the Great Depression in 1929. What researchers found was a perfectly inverse correlation between time held and the probability of negative returns.
As you can see from the chart above, if you hypothetically purchased an S&P 500 index fund and held that position for a single day, there would be a 46% probability of losing money on that investment. If your holding time extends to one month or one year, the probability of negative returns would decline to 38% and 25%, respectively.
But hold that same S&P 500 tracking fund for 10 or 20 years, and the probability of negative returns falls to 6% and 0%, respectively. That's right: There has never been a rolling 20-year period during which the S&P 500 hasn't generated a positive total return.
While it can be difficult to exhibit patience during short-lived periods of tumult, it truly is a virtue when investing on Wall Street.
