This Bull Market Indicator Hasn't Been Wrong in 67 Years, and It Has a Clear Message for Where Stocks Head Next
When examined with a wide lens, the stock market is an unstoppable beast. On an annualized basis, it's outpaced the returns of bonds, gold, oil, housing, and the certificates of deposit (CDs) you'd find at your local bank or credit union over many decades.
But narrow your focus, and Wall Street becomes entirely unpredictable. Over the past 2 1/2 years, the iconic Dow Jones Industrial Average (^DJI 0.13%), broad-based S&P 500 (^GSPC 0.11%), and growth-dominated Nasdaq Composite (^IXIC 0.16%) have surged to multiple all-time closing highs, then plunged into a bear market. In 2022, the Dow, S&P 500, and Nasdaq produced their worst full-year returns since the Great Recession.
Volatility and unpredictability of this nature repeatedly lead investors to ponder one question: When will it end? The answer, according to one tried-and-true indicator, is that the worst is over.
This stock market indicator hasn't been wrong since 1956
From peak to trough, the S&P 500 endured a 282-calendar-day bear market (Jan. 3, 2022-Oct. 12, 2022), which saw the index decline by roughly 25%. This 282-day bear market is more or less the average length of a bear market for the benchmark index over the past 94 years (i.e., since the start of the Great Depression).
But what's far more interesting than reminiscing on how much the S&P 500 declined during previous bear markets or how long each bear market lasted is analyzing how the widely followed index performed once an official bull market was declared. An "official" bull market begins once the S&P 500 bounces 20% from its bear market closing low. Based on Thursday's close (June 8) of 4,293.93, the S&P 500 is no longer in a bear market.
According to Ryan Detrick, chief market strategist at Carson Group, who's been pounding the table on the upside for equities since 2023 began, this is very good news for stocks.
This won't make the perma🐻, M2, and yield curve inversion crowds very happy, but oh well.
Once stocks are >20% off bear lows (currently 19.7% above Oct '22 lows) did you know a yr later stocks have never been lower?
Up 28.2% on avg and 6 mo returns are solid as well.
🐂🎯 pic.twitter.com/3SJ6nC9xWN -- Ryan Detrick, CMT (@RyanDetrick) June 4, 2023
As you can see in the tweet above from Detrick, new bull markets following steep or lengthy bear market declines tend to have legs. Over the past 67 years, every new bull market was higher one year after officially beginning.
Take note, these aren't marginal gains, either. The average bull market gained an additional 28.2% in the 12-month period after bouncing 20% off of bear market lows. For what it's worth, every bull market was also higher at the six-month mark, with double-digit gains in six out of seven instances.
This isn't the only highly convincing data point Detrick has provided in recent weeks. For instance, Detrick and Carson Investment Research noted that if the S&P 500 is higher by at least 7% on a year-to-date basis by the 100th day of trading, the benchmark index has closed the year with a positive return all 26 times since 1950. This year marks the 27th time we've seen the S&P 500 rise by at least 7% as of the 100th trading session.
The point is that Detrick's data sets send a very clear message to Wall Street and investors that stocks should once more be heading notably higher over the next 12 months, assuming history rhymes.
Maybe this time could be different...
Although Ryan Detrick has been spot-on with his prognostications thus far in 2023, and investors certainly prefer seeing green over red in their portfolios, this very well could be the year that Detrick's data set fails to deliver. With the understanding that one of Wall Street's most dangerous phrases (because it's often wrong) is "this time could be different," this time really could be different.
To begin with, the consensus for a U.S. recession is growing. The Federal Open Market Committee's March meeting minutes noted that the 12-member body responsible for monetary policy decisions had incorporated a "mild recession" into its outlook for later this year.
Additionally, the Federal Reserve Bank of New York's recession probability tool, which analyzes the spread (difference in yield) in the yield curve between the three-month and 10-year Treasury bonds, is at a 70.85% recession probability within 12 months. That's the highest recession probability reading in more than four decades. Recessions tend to be bad news for equities, with the bulk of downside occurring after, not prior to, an official recession being declared.
Another sign of concern is commercial bank lending. In a healthy economy, banks are eager to lend money to cover the costs of taking deposits (e.g., interest, teller/employee salaries, etc.). When bank lending standards tighten, it's often a warning to Wall Street.
There have been only four occasions in the last half-century where total commercial bank credit has declined by at least 1.5% from an all-time high. The previous three instances saw the S&P 500 fall by approximately 50% each time. The fourth is ongoing right now. If banks are considerably pickier about what businesses they lend to, it's rarely a good sign for the U.S. economy.
Sticking with financial metrics, M2 money supply is, perhaps, the most damning of all indicators. M2 money supply accounts for everything in M1 (cash, coins, money in a checking account, and traveler's checks) and adds money market funds, savings accounts, and CDs below $100,000.
M2 has been rising almost steadily for more than 150 years. That's because a growing economy requires more cash to pay for goods and services. In rare instances, M2 money supply has contracted. A situation wherein the inflation rate is making goods and services costlier and M2 is contracting can lead to consumers passing on discretionary purchases. From its all-time high in July 2022, M2 has contracted by 4.8%. It's the first contraction in money supply in 90 years and a potential warning of trouble to come for the U.S. economy.
The one tool that never fails investors
What happens when historically infallible data sets signaling a bull market run is imminent go head-to-head with financial metrics that haven't faltered in decades, perhaps more than a century? Your guess is as good as mine over the next couple of months.
What I can tell you is there's one tool that hasn't failed investors for more than a century: patience.
I'll admit that it can be difficult to be patient when the Dow Jones, S&P 500, and Nasdaq Composite are being whipsawed by emotion and adding or losing 2%, 3%, or 4% in a single session. Emotions tend to be at their peak during bear market downdrafts. But patience and time have consistently paid off for long-term investors.
Think about it this way: There have been dozens upon dozens of corrections since trading began on Wall Street two centuries ago. No matter how dire things may have seemed at the time, the major indexes always eventually (key word!) recoup their losses. While it's true that we're never going to know ahead of time when downturns will begin or how far the Dow, S&P 500, or Nasdaq will fall, we do have pretty conclusive historical evidence that these indexes rise in value over time.
In fact, market research company Crestmont Research proved this point. It examined 104 separate rolling 20-year periods for the S&P 500 (1919-2022), beginning in 1900. Crestmont's data showed that, hypothetically, if an individual purchased the S&P 500 (or a tracking fund that mirrored its movements) and held their position for 20 years, they generated a positive total return, including dividends, every single time.
Timing the market and debating whether stocks are up or down in a few months hasn't mattered because the Dow, S&P 500, and Nasdaq Composite have always been up when examined over multiple decades.
Source: The Motley Fool
