Three forecasting tools suggest a rocky path ahead for Wall Street.
Historically, Wall Street has been a solid wealth generator, outperforming other asset classes like bonds and real estate with its average annual returns over more than a century.
Currently, Wall Street is experiencing a robust bull market. Since the beginning of 2023, the Dow Jones Industrial Average (^DJI -0.12%), S&P 500 (^GSPC -0.41%), and Nasdaq Composite (^IXIC -0.71%) have risen by 18%, 43%, and 71%, respectively, as of June 27, 2024.
However, stocks rarely move in a straight line. Despite the current bullish sentiment driven by artificial intelligence (AI) and stock-split enthusiasm, three indicators historically linked to market downturns suggest a potential stock market crash in 2024.
A Historic Decline in U.S. M2 Money Supply
While no metric can accurately predict short-term market movements, some indicators have been reliable in forecasting downturns. One such indicator is the U.S. M2 money supply.
M2 includes M1 (cash, coins, and demand deposits) plus money market accounts, savings accounts, and small-denomination certificates of deposit (CDs). For nine decades, M2 has consistently expanded to support economic growth.
However, since peaking in April 2022, M2 has significantly declined, dropping by 3.49% from its all-time high. Historically, substantial declines in M2 have correlated with periods of high unemployment and economic depressions, suggesting reduced consumer spending and potential recession.
The Longest Yield-Curve Inversion of the Modern Era
Another warning sign is the Treasury yield curve inversion. Typically, longer-term bonds have higher yields than short-term ones. Since July 5, 2022, the yield on two-year Treasury bills has surpassed that of 10-year bonds, marking the longest yield-curve inversion in modern times.
Yield-curve inversions have preceded every U.S. recession since World War II, with around two-thirds of the S&P 500’s peak-to-trough declines occurring during recessions. While not all inversions lead to recessions, they indicate economic headwinds.
Exceptionally High Stock Valuations
The third warning comes from the Shiller price-to-earnings (P/E) ratio, which accounts for average inflation-adjusted earnings over the past 10 years. The S&P 500’s Shiller P/E ratio is currently at 35.70, more than double its historical average.
Historically, when the Shiller P/E ratio exceeds 30, significant market downturns have often followed. While the timing varies, high valuations are typically not sustained, signaling potential bear markets.
Time and Perspective
Although these indicators suggest potential trouble, they don’t guarantee a market crash. Short-term predictions are inherently uncertain.
However, taking a long-term perspective reveals that recessions and market corrections are normal parts of the economic cycle. Since World War II, most U.S. recessions have lasted less than a year, while periods of economic growth have been much longer.
For example, from 1929 to 2023, the average bull market for the S&P 500 lasted 1,011 days, about 3.5 times longer than the average bear market of 286 days. Nearly half of these bull markets outlasted the longest bear markets.
Additionally, data from Crestmont Research shows that all 105 rolling 20-year periods from 1919 to 2023 yielded positive returns for the S&P 500. This demonstrates that a long-term investment approach has consistently delivered positive outcomes, despite short-term volatility.
In summary, while short-term indicators point to potential challenges, a long-term perspective and historical data suggest that the market will continue to grow over time.
