The past couple of years have been a much-needed reminder for investors that stock market movements can be unpredictable.
In 2021, the long-established Dow Jones Industrial Average (^DJI -0.69%), benchmark S&P 500 (^GSPC -1.12%), and growth stock-driven Nasdaq Composite (^IXIC) powered to multiple record-closing highs. Last year, all three indexes spilled into a bear market, with the Nasdaq Composite shedding a third of its value.
Image source: Getty Images.
Although stock market corrections and bear markets are more common than most people probably realize, they’re still known for tugging on investors’ emotions and coercing rash decisions. The velocity of downside moves and uncertainty that bear markets bring has investors rightly wondering when the good times will return for Wall Street.
According to one stock market indicator, the return of the bull could come far sooner than many expect.
This widely followed index has a knack for predicting the future (under certain parameters)
The best thing about this “indicator” in question is that it’s not obscure by any means. I’m talking about the prominent, and currently outperforming, Nasdaq 100.
The Nasdaq 100 is a widely followed index composed of the 100 largest nonfinancial companies listed on the Nasdaq stock exchange. The extremely popular Invesco QQQ Trust is the exchange-traded fund that tracks the performance of the Nasdaq 100.
What’s most notable is what happens when the Nasdaq 100 makes a new 52-week high following at least a six-month period without notching a new high.
Nasdaq 100 (NDX) made a new 52-wk high for the first time in nearly 18 mos today.
Do you know what happened the previous times it went >6 mos w/o one and then finally made a new high?
A yr later higher 14 of 14 times.
Sure, this time ‘could be different’, but I doubt it. pic.twitter.com/UgH1WCrEth
— Ryan Detrick, CMT (@RyanDetrick) May 19, 2023
As you can see in the tweet above from Carson Group’s Chief Market Strategist Ryan Detrick, there have been 15 instances since 1985 when the Nasdaq 100 took between 6.8 months and 38 months to reach a new 52-week high, including the occurrence from last week. In all previous 14 instances when it took at least half a year to eventually reach a new 52-week high, the Nasdaq 100 was green 12 months later.
There are two important things to note about Detrick’s dataset. First of all, the Nasdaq 100 has typically crushed it after going an extended period without hitting a new 52-week high. In 10 out of 14 instances, the index delivered double-digit percentage gains in the 12 months that followed.
The other consideration here is that the Nasdaq 100 is comprised of many of the country’s leading innovators. This includes the FAANG stocks, as well as cutting-edge outperformers like artificial intelligence kingpin Nvidia and electric vehicle manufacturer Tesla. These large-cap and megacap companies can be found in the market cap-weighted S&P 500 and Nasdaq Composite, and even the share price-weighted Dow Jones Industrial Average. If the Nasdaq 100 is climbing, there’s a real chance it can bring the rest of the major indexes with it.
A historically long streak is set to end, one way or another
Whereas Ryan Detrick has pointed out a well-defined bullish trend in the Nasdaq 100 spanning 38 years, there is also no shortage of market indicators and metrics that offer an ominous warning for stocks going forward.
10 Year-3 Month Treasury Yield Spread data by YCharts. Gray areas denote U.S. recessions.
One of the best examples can be seen with the Federal Reserve Bank of New York’s recession-probability tool, which analyzes the spread between three-month and 10-year Treasury bond yields to predict the likelihood of a U.S. recession over the coming 12 months. Recently, the three-month and 10-year notes endured their largest yield-curve inversion in more than four decades.
There have been eight occasions since 1959 when the NY Fed’s recession indicator surpassed 40%. One of these instances, in October 1966, proved incorrect. However, this recession-probability tool hasn’t been wrong over the past 57 years. The current recession probability of 68.22%, as of April 2023, is the highest in about 42 years.
Another solid example is the Conference Board Leading Economic Index (LEI), which has never been wrong in 64 years. The LEI is comprised of 10 inputs that are designed to “anticipate turning points in the business cycle by around seven months.” It’s measured as a six-month annualized growth rate, compared to the comparable prior-year period.
The line-in-the-sand level for the LEI has historically been a decline of 4%. There hasn’t been one instance after 1959 where an LEI drop of 4% (or greater) hasn’t, eventually, led to a recession. The LEI dipped by more than 4% in December 2022 and has been declining for 13 months.
WARNING: the Money Supply is officially contracting. 📉
This has only happened 4 previous times in last 150 years.
Each time a Depression with double-digit unemployment rates followed. 😬 pic.twitter.com/j3FE532oac
— Nick Gerli (@nickgerli1) March 8, 2023
Even U.S. money supply provides a potential warning. After exploding higher by a record 26% between early 2020 and early 2021, M2 money supply (cash, coins, and traveler’s checks, plus savings accounts, money market funds, and certificates of deposit under $100,000) has now fallen 4.1% from the previous year. That’s the largest year-over-year contraction in M2 money supply since 1933.
The previous four instances where M2 contracted by at least 2% resulted in three depressions and a panic. To be fair, these events occurred 90 to 150 years ago, and the Federal Reserve has far better tools and knowledge at its disposal today to prevent depressions from occurring. Nevertheless, the growing likelihood of a recession bodes poorly for Wall Street.
One way or another, a historically long streak is going to end. Either the Nasdaq 100 will fail to deliver for optimists, or these aforementioned indicators and metrics that predict a recession or downside in equities will see their long forecast streaks come to a close.
Image source: Getty Images.
Patience continually pays off on Wall Street
For long-term investors, the answer is simple: Don’t sweat the small stuff. While the Dow Jones, S&P 500, Nasdaq Composite, and even Nasdaq 100, can be unpredictable over short periods, there’s absolutely no question where the trend points once you widen the lens a bit.
Statistically speaking, it pays to be an optimist. The S&P 500 has spent 2.6 calendar days expanding for every one calendar day it’s spent in a correction since the start of 1950. What’s more, every single crash, correction, and bear market throughout history, save for the current bear market, has eventually been fully recouped by a bull market.
Patience pays no matter what any of the aforementioned indicators and metrics suggest is coming.
Sean Williams has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Nvidia and Tesla. The Motley Fool recommends Nasdaq. The Motley Fool has a disclosure policy.