For over 150 years, these metrics have perfectly foreshadowed trouble to come for Wall Street and/or the U.S. economy.
With just two trading days left before 2024 comes to a close, it’s fair to say this will be another successful year for Wall Street and everyday investors. The ageless Dow Jones Industrial Average (^DJI -0.77%), benchmark S&P 500 (^GSPC -1.11%), and growth stock-inspired Nasdaq Composite (^IXIC -1.49%) have all reached multiple all-time highs this year and gained 15%, 27%, and 33% on a year-to-date basis, as of the closing bell on Dec. 24.
Numerous catalysts are responsible for lifting Wall Street’s tide, including:
However, Wall Street is a forward-looking entity, and the shift to a new calendar year brings forth the age-old question: “Will stocks move higher in 2025?”
Image source: Getty Images.
Although bull market rallies tend to stick around considerably longer than downturns, two historically flawless indicators foreshadow trouble for the stock market in the new year.
This valuation tool has forecast stock market declines of 20% to 89% over the last 154 years
Among the various forecasting tools and predictive metrics that point to potential trouble for Wall Street, arguably none is more worrisome than the S&P 500’s Shiller price-to-earnings (P/E) Ratio, which is also commonly referred to as the cyclically adjusted P/E Ratio (CAPE Ratio).
The most rudimentary of all valuation tools is the P/E ratio, which is calculated by dividing a company’s share price into its trailing-12-month earnings per share (EPS). This traditional valuation metric works great on time-tested companies but can be easily thrown off by economic shocks and growth stocks.
In comparison, the S&P 500’s Shiller P/E is based on average inflation-adjusted earnings over the previous 10 years. Accounting for a decade of EPS history ensures that a shock event, such as lockdowns during the early stages of the COVID-19 pandemic, won’t render this valuation metric ineffective.
S&P 500 Shiller CAPE Ratio data by YCharts.
On Dec. 24, the S&P 500’s Shiller P/E Ratio closed at 38.35, which is within striking distance of its yearly high of almost 39. For added context, this is more than double its average reading of 17.19 over the last 154 years and represents the third-highest reading during a continuous bull market since January 1871.
Here’s where things get interesting: There have been only six occurrences of the Shiller P/E surpassing 30 during a bull market rally in 154 years, including the present, and all five prior instances saw the Dow Jones Industrial Average, S&P 500, and/or Nasdaq Composite eventually lose between 20% and 89% of their value.
Although the Shiller P/E doesn’t tell investors when these declines will take place, it does have a flawless track record of being a harbinger of eventual big-time downside. In other words, it pretty clearly shows that outsized stock valuations aren’t well-tolerated over extended periods.
U.S. money supply hadn’t done this since the Great Depression — and it (historically) spells trouble
However, the Shiller P/E Ratio isn’t the only indicator that has a historically flawless track record of forecasting significant downside in the stock market. A move we haven’t witnessed in 90 years in U.S. money supply is an ominous warning, as well.
Though there are five measures of money supply, the two given the most credence are M1 and M2. The former factors in cash and coins in circulation, along with demand deposits in a checking account. Meanwhile, M2 takes everything into account from M1 and adds in savings accounts, money market accounts, and certificates of deposit (CD) below $100,000. It’s this latter money-supply measure, M2, which has raised red flags.
US M2 Money Supply data by YCharts.
In April 2022, U.S. M2 money supply peaked at $21.723 trillion. As of October 2024 (the latest reading at the time of this writing), M2 had retraced by $412 billion to $21.311 trillion, or 1.89%. But on a peak-to-trough basis, it fell by a maximum of 4.74% between April 2022 and October 2023. This marked the first time since the Great Depression that M2 declined by at least 2% on a year-over-year basis.
Normally, M2 money supply moves up and to right — so much so that economists rarely pay it much attention. A growing economy requires more capital available to facilitate transactions, which led to 90 years without a notable year-over-year decline in M2.
There have been five instances since the start of 1870 where M2 slipped by at least 2% from the prior-year period: 1878, 1893, 1921, 1931-1933, and 2023. The four prior occurrences correlate with periods of economic depression and double-digit unemployment rates in the U.S.
If there’s a silver lining here, it’s that the tools available to the central bank and federal government make it highly unlikely that the U.S. would endure a modern-day depression. Likewise, M2 has reversed course and climbed since October 2023.
Nevertheless, M2 being close to 2% below its all-time high signals that consumers are likely to pass on some discretionary purchases. This is a recipe for economic weakness, which would be expected to spill over onto Wall Street in 2025.
Image source: Getty Images.
The view beyond 2025 is brighter than ever for Wall Street
Based on these two indicators, which have a perfect track record of foreshadowing significant downside in the stock market when back-tested more than 150 years, a crash is a possibility for 2025. While this may not be what investors want to hear following another stellar year for the Dow Jones, S&P 500, and Nasdaq Composite, it’s simply what history tells us to expect.
But the interesting thing about history is that it tends to favor optimists far more than pessimists.
For instance, history tells us that recessions are a normal and unavoidable part of the economic cycle. No amount of fiscal or monetary policy maneuvering can stop economic downturns from taking shape every so often.
Yet there’s a big difference between the length of economic downturns and upswings. Among the 12 U.S. recessions to have taken place since the end of World War II in September 1945, nine were resolved in less than a year. Of the remaining three, none surpassed 18 months in length. Compare this to the last one dozen economic expansions, two of which stuck around for more than 10 years.
To quote billionaire investor Warren Buffett, “Never bet against America.”
Along these same lines, betting against the U.S. stock market has been a poor decision over long periods.
It’s official. A new bull market is confirmed.
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
— Bespoke (@bespokeinvest) June 8, 2023
The data set above was posted on social media platform X by Bespoke Investment Group in June 2023, shortly after the S&P 500 was confirmed to be in a new bull market following its October 2022 bear market low. It shows the calendar-day length of every S&P 500 bear and bull market since the Great Depression began in September 1929.
Over this roughly 94-year period, there were 27 separate bear and bull markets for the S&P 500. The average bear market lasted only 9.5 months, or 286 calendar days. Comparatively, the typical bull market (as of June 8, 2023) endured for 1,011 calendar days, or approximately 3.5 times as long.
If this data set were extrapolated to the present day, the current bull market would be lengthier than the longest S&P 500 bear market over the last 95 years (630 calendar days). In fact, more than half (14 out of 27) of S&P 500 bull markets since September 1929 have lasted longer than 630 calendar days.
Even with two historically flawless indicators foreshadowing a possible crash for the stock market in 2025, the long-term outlook for stocks remains bright.
