Since hitting a bear market low just over two years ago, the bulls have dominated the show on Wall Street. This year, the timeless Dow Jones Industrial Average (DJINDICES: ^DJI)benchmark S&P500 (SNPINDEX: ^GSPC)and dependent on growth stocks Nasdaq Composite (NASDAQINDEX: ^IXIC) have reached several all-time highs.
The wind in Wall Street’s sails has been a team effort, with the artificial intelligence (AI) revolution, stock split euphoria, better-than-expected corporate results, a resurgence in share buybacks and optimism following the new president. Donald Trump’s victory is all leading the charge.
Start your morning smarter! Wake up with Breakfast news in your inbox every market day. Register for free »
While this collection of catalysts may seem unstoppable at first glance, history offers a different lesson.
Since the height of the 2022 bear market, there have been a number of predictive tools and related events that have predicted trouble for the US economy and/or Wall Street. The longest yield curve inversion in history, a historically high price-to-earnings ratio for the S&P 500 Shiller, and the first meaningful decline in the US M2 money supply since the Great Depression all previously served as warning signs for Wall Street.
But perhaps nothing screams ‘take note’ for investors more than the long-term valuation metric Berkshire Hathaway‘s billionaire CEO Warren Buffett once touted.
In a 2001 interview with Fortune Magazine, Buffett praised the ratio of market capitalization to gross domestic product (GDP) as “probably the best measure of the state of valuations at any given point in time.” Although the aptly named Oracle of Omaha has moved away from relying solely on this valuation tool, it is commonly referred to on Wall Street as the “Buffett Indicator.”
The Buffett Indicator takes the collective market value of a country’s listed stocks and divides that figure into GDP. The lower the ratio, the cheaper shares are considered to be. Conversely, when the ratio is high, it indicates that stocks are historically expensive compared to the economy’s underlying growth rate.
The most effective way to measure the value of publicly traded stocks in the US is using the Wilshire 5000 Index. Each “point” higher or lower in the Wilshire 5000 Index represents just over $1 billion in gain or loss in the total market value of U.S. stocks.
Based on 55 years of Wilshire 5000-GDP ratio data collected by Longtermtrends.net, the average value of this “Buffett Indicator” is approximately 85%. In other words, the cumulative value of U.S. stocks represents, on average, about 85% of the value of U.S. GDP, dating back to the early 1970s.
But after being below this average for nearly three decades (from 1970 through most of 1998), the Wilshire 5000-GDP ratio has been at a premium to this average for almost all of the last quarter century. In some ways, a more aggressive valuation is warranted. The advent of the Internet has positively changed the growth trajectory for corporate America. Likewise, it democratized access to information, which, combined with historically low interest rates, prompted ordinary investors to take on more risk.
However, the stock market just crossed a threshold that this widely followed ratio has never reached. In October, the Buffett Indicator exceeded 200% for the first time ever, peaking at almost 206% on November 10. This is well above the 55-year average and significantly higher than the respective peaks of 144% during the dot period. -com bubble and 107% before the financial crisis took shape.
While the Wilshire 5000-GDP ratio is not a timing tool—that is, it won’t tell investors when to expect big directional moves in the Dow Jones, S&P 500, and Nasdaq Composite—it does have an exceptionally strong track record of predicting a downtrend in stocks when valuations reach historic highs.
-
A significant jump in the Buffett Indicator from 60% to 144% from late 1994 until the bursting of the Internet bubble in March 2000 gave way to a near halving of the S&P 500 and significantly larger losses for the tech-heavy Nasdaq. .
-
Another notable increase occurred between the dot-com bubble low of 67% in October 2002 and the aforementioned Wilshire 5000-GDP ratio of 107% achieved in 2007 before the financial crisis took shape. The benchmark S&P 500 lost 57% during the Great Recession.
-
Since bottoming out at 112% on March 22, 2020 (during the height of the COVID-19 crash), the Wilshire 5000-to-GDP ratio has risen to the aforementioned 206%. If history teaches us anything, it’s that investors should possibly (key word!) expect a steep and/or sharp decline lower in all three major stock indexes.
While warning signs are clearly visible for a historically expensive stock market, perspective and time paint a very different picture.
For example, history teaches us that recessions are a normal and inevitable part of the economic cycle. As much as we hate the negative effects on employment and wages that come with recessions, they are common in the long run.
However, the ability of employees/investors to step back and broaden their lens presents a different story. Although recessions are normal, they have resolved rapidly since the end of World War II in 1945. Of the twelve downturns in the U.S. economy over the past 79 years, nine ended in less than a year, while the remaining three failed to outpace the recession. For 18 months. The vast majority of economic expansions have lasted longer than the longest recession of the post-World War II era.
What the above equation shows is that economic cycles are not linear. In other words, the U.S. economy spends a disproportionate amount of time in the sun, rather than under storm clouds. This is fantastic news for America’s most influential companies, because this non-linearity extends to the stock market.
The dataset you’ll note above was published on social media platform What this data set shows is the calculated calendar day length of every bear and bull market for the S&P 500, going back to the start of the Great Depression in September 1929.
The average bear market in the S&P 500, in which the index declines at least 20% from a recent high, is expected to last 286 calendar days, or roughly 9.5 months. On the other end of the spectrum, the typical bull market lasts for 1,011 calendar days, which is about 3.5 times as long.
Even more telling, 14 of the 27 S&P 500 bull markets (including the current bull market) have outlasted the S&P 500’s longest ever bear market (630 calendar days).
As worrying as predictive numbers may seem over a short period of time, they can’t match investors’ greatest ally: time.
Have you ever felt like you missed the boat on buying the most successful stocks? Then you would like to hear this.
On rare occasions, our expert team of analysts provides a “Double Down” Stocks recommendation for companies they think are about to pop. If you’re worried that you’ve already missed your chance to invest, now is the best time to buy before it’s too late. And the numbers speak for themselves:
-
Nvidia: If you had invested $1,000 when we doubled in 2009, you would have $368,053!*
-
Apple: If you had invested $1,000 when we doubled in 2008, you would have $43,533!*
-
Netflix: If you had invested $1,000 when we doubled in 2004, you would have $484,170!*
We’re currently issuing ‘Double Down’ warnings for three incredible companies, and another opportunity like this may not happen anytime soon.
See 3 “Double Down” Stocks »
*Stock Advisor returns November 18, 2024
Sean Williams has no position in any of the stocks mentioned. The Motley Fool holds positions in and recommends Berkshire Hathaway. The Motley Fool has a disclosure policy.
The Stock Market Just Crossed a Threshold Never Reached Before – and History Is Pretty Clear on What Will Happen Next Originally published by The Motley Fool
