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This Forecasting Tool Hasn’t Been Wrong in 70 Years, and It Has a Warning for Wall Street

Stock Market Crash Plunge Dollar Newspaper Invest Dow SP 500 Getty

Stock Market Crash Plunge Dollar Newspaper Invest Dow SP 500 Getty

Pardon the cliché, but Wall Street’s only given in the short-term is that there is no such thing as a given. Since this decade began, the ageless Dow Jones Industrial Average (DJINDICES: ^DJI), broad-based S&P 500 (SNPINDEX: ^GSPC), and growth-propelled Nasdaq Composite (NASDAQINDEX: ^IXIC), have traded off bear and bull markets in successive years.

When the closing bell tolled on Dec. 14, the Dow Jones was at an all-time high, while the S&P 500 and Nasdaq Composite were respectively higher by 23% and 41% year to date. Although it’s been a banner year for stocks, most investors are focused on what comes next for Wall Street.

A twenty dollar bill paper airplane that's crashed and crumpled into a financial newspaper.

Image source: Getty Images.

While there’s no such thing as a concrete datapoint or predictive tool that can, with 100% accuracy, forecast short-term directional movements for the Dow, S&P 500, and Nasdaq Composite, there are a small number of metrics and forecasting models that have amazingly accurate track records.

One such forecasting tool, which was last wrong 70 years ago, offers a warning for Wall Street and investors for the coming year.

This prognosticating indicator has been flawless since the early 1950s

In recent weeks, I’ve looked at a number of money-based metrics and economic datapoints and examined how they’ve been strongly correlated with directional moves for the stock market over the past half-century, if not longer. The newest forecasting tool to the add to the list is the ISM Manufacturing New Orders Index.

The ISM Manufacturing New Orders Index is a subcomponent of the far more popular ISM Manufacturing Index, which is commonly known as the Purchasing Managers’ Index (PMI). What the monthly reported ISM Manufacturing New Orders Index examines via survey is industrial order activity in the United States.

I know what you’re probably thinking: “Is industrial order activity still a relevant measure of economic success given the growing emphasis on technology/software in the U.S. economy?” The answer is yes. Even though industrial activity isn’t what it was four decades ago, it’s still a key tool used to gauge the health of the U.S. economy.

US ISM Manufacturing New Orders Index Chart

US ISM Manufacturing New Orders Index Chart

The ISM Manufacturing New Orders Index is measured on a scale of 0 to 100, with 50 acting as the baseline. Any number above 50 signals expansion of U.S. industrial order activity. Conversely, a figure below 50 marks contraction in industrial orders.

As you can see from the chart above, the November reading came in at 48.3, which represents a modest level of contraction. But that only tells one very small part of the story.

The contraction in November marked the 15th consecutive month that the ISM Manufacturing New Orders Index has come in below 50. Likewise, the PMI also registered its 15th straight month of contraction. It’s been 40 years since the PMI was in contraction territory for 15 consecutive months, and it’s never been in contraction for this many consecutive months without a U.S. recession taking shape.

What’s more, the ISM Manufacturing New Orders Index has a clear, yet arbitrary, line-in-the-sand reading that’s previously been a precursor to recessions over the past 70 years. Although modest dips below 50 aren’t too concerning, readings below 43.5 have been followed by an eventual U.S. recession, without fail, for seven decades. This level has been breached twice over the past 15 months, which if history rhymes would suggest a recession is coming,

Although the U.S. economy and stock market don’t move in tandem, corporate earnings are ultimately dependent on the health of the U.S. and global economy. Historically, around two-thirds of the S&P 500’s drawdowns have occurred after, not prior to, a U.S. recession being declared by the National Bureau of Economic Research. In other words, it’s a pretty clear warning that turbulence may lie ahead for stocks.

A person reading a financial newspaper while seated at a kitchen table in their home.

Image source: Getty Images.

Patience is a virtue — and a moneymaker — on Wall Street

Given how voracious the Dow Jones Industrial Average, S&P 500, and Nasdaq Composite have rallied this year, the idea of economic weakness or a potential 2024 bear market might sound laughable. But even if history rhymes, once more, and equities struggle during a Fed rate-easing cycle, investors would be smart to remain patient and look for long-term opportunities.

Let’s be honest, no one enjoys economic downturns. During recessions, the unemployment rate rises, wage growth slows or shifts into reverse, and stock valuations drop. Over the past eight recessions, the S&P 500 has endured a peak-to-trough decline ranging from 17% to 57%.

But as with monthly ISM Manufacturing Index readings, this tells only a small part of the story. Though downturns are a normal part of the economic cycle, so are periods of expansion. The thing about economic expansions is they last considerably longer than recessions. There have been two expansions since the end of World War II that stuck around for longer than a decade, while none of the 12 recessions over the past 78 years have lasted longer than 18 months.

And it’s not just that the U.S. economy spends a disproportionate amount of its time expanding, relative to contracting. We see this in the Dow, S&P 500, and Nasdaq, too!

Since the start of 1950, there have been 39 separate instances where the benchmark S&P 500 has declined by a double-digit percentage. With the exception of the 2022 bear market, the S&P 500 has eventually put these corrections and bear markets in the rearview mirror and pushed to new all-time highs.

The analysts at Bespoke Investment Group took things one step further and examined the length of bull and bear markets in the S&P 500 dating back to the start of the Great Depression in Sept. 1929. All told, Bespoke examined 27 separate bull and bear markets.

Bespoke’s calculations show that the average bear market for the S&P 500 spanning the past 94 years has lasted 286 calendar days, or about 9.5 months. That compares to the typical bull market, which hangs around for 1,011 calendar days, or 3.5 times longer than the average bear market.

Investors who take an optimistic, long-term approach are statistically positioned for success, no matter what Wall Street or the U.S. economy throws their way.

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Sean Williams has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

This Forecasting Tool Hasn’t Been Wrong in 70 Years, and It Has a Warning for Wall Street was originally published by The Motley Fool

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