What will the stock market do next? That's the question every investor would love to be able to answer correctly. Unfortunately, there's no way to know what stocks will do. Or is there?
Many investors like to look at indicators that have been reliable in the past to get a feel for which direction the market could move. There's one indicator that has called every bull market since 1960. Here's what it's saying stocks will do now.
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Flashing that a new bull market is starting
This indicator I'm talking about doesn't have a catchy name. However, it's easy to understand.
The first prerequisite in using the indicator is that the S&P 500 must have declined by at least 20%. We can check that off the list. The index fell by more than 25% below its previous high in mid-October last year.
With that established, we then must look at the 10-month moving average for the S&P 500. This moving average is the average closing price of the index over the previous 10 months. The indicator flashes that a bear market is ending and a new bull market is beginning any time the S&P 500 closes above its 10-month moving average for two consecutive months.
That's exactly what the major index did in the first two months of 2023. The S&P easily closed above its 10-day moving average in January with a nice rebound underway. This momentum sputtered somewhat in February. However, the S&P only needed to close above 3,947 for the indicator to signal a new bull market. It finished the month at 3,970.
A great track record
The S&P 500 has closed above its 10-month moving average for two consecutive months 14 times since 1960 after the index fell by at least 20%. In every instance, the indicator correctly signaled a new bull market.
Moving-average indicators tend to lag market momentum somewhat. That's the case with this indicator. For example, the longest bull market in history began in March 2009. However, the S&P 500 didn't close for two months in a row above the 10-month moving average until July 2009.
It was a similar story in the most recent bull market. The COVID-19 scare caused the S&P 500 to crash in February 2020. By the following month, a new bull market had begun. But the index didn't close for two months above its 10-month moving average until June 2020.
Because of this delayed effect, we can't really claim that this indicator always predicts a bull market. However, it certainly has a great track record of confirming that the S&P 500 is in a new bull market.
Clash of the indicators
So is a new bull market inevitable? Not necessarily. Actually, there seems to be a major clash of historically reliable indicators.
For example, in all 12 bear markets since the end of World War II, the market didn't bottom out until a recession was officially declared by the National Bureau of Economic Research (NBER). No recession has been declared so far. This indicator hasn't been wrong in 77 years -- an even more impressive track record than that of the indicator we've discussed.
There's also another telltale bear market indicator that has never been wrong. When the Shiller cyclically adjusted price-to-earnings (CAPE) ratio has gone above 30, it has signaled major market declines going all the way back to 1870. Granted, the indicator didn't forecast every bear market. But every time it flashed, a bear market ultimately came.
No indicator is 100% foolproof, though. Maybe the S&P 500 will begin a new bull market; maybe it won't. What investors can be sure of, though, is that the stock market has always delivered positive returns over 20-year periods and has almost always done so during five-year periods. Long-term investors don't have to look at any indicator to feel good about their prospects for achieving positive returns.
I'm an enthusiast well-versed in financial markets and stock market indicators, with a demonstrated understanding of various indicators' historical performance. Let's delve into the concepts mentioned in the article and provide additional insights:
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Bear Market and Bull Market:
- A bear market is characterized by a decline of at least 20% in a major stock index, indicating pessimism and selling pressure.
- A bull market is the opposite, marked by an upward trend and positive investor sentiment.
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S&P 500:
- The S&P 500 is a stock market index that measures the performance of 500 large companies listed on stock exchanges in the United States.
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10-Month Moving Average:
- A moving average is a statistical calculation that helps smooth out price data by creating a constantly updated average price. In this case, it's a 10-month moving average of the S&P 500.
- The article suggests that when the S&P 500 closes above its 10-month moving average for two consecutive months after a 20% decline, it signals the end of a bear market and the start of a new bull market.
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Historical Performance:
- The article claims that this particular indicator has accurately predicted the beginning of a new bull market 14 times since 1960 when the S&P 500 experienced a 20% decline.
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Market Lag and Momentum:
- The article acknowledges that moving-average indicators, including this one, might lag behind actual market momentum. It gives examples of past instances where the indicator signaled a new bull market after a delay.
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Clash of Indicators:
- The article introduces conflicting indicators, such as the correlation between market bottoms and official recessions declared by the National Bureau of Economic Research (NBER).
- Another conflicting indicator mentioned is the Shiller cyclically adjusted price-to-earnings (CAPE) ratio, which historically signaled major market declines when exceeding 30.
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Shiller CAPE Ratio:
- The Shiller CAPE ratio is a valuation measure that uses real earnings per share over a 10-year period to smooth out fluctuations in corporate profits. It's used to assess whether the market is overvalued or undervalued.
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Long-Term Investing:
- The article concludes by emphasizing that while indicators provide insights, no indicator is foolproof. It highlights the historical positive returns of the stock market over 20-year and five-year periods, encouraging long-term investors to stay optimistic.
In summary, the article discusses a specific indicator based on the 10-month moving average of the S&P 500, its historical reliability, and presents conflicting signals from other indicators, leaving the ultimate direction of the market uncertain. It underscores the importance of considering multiple indicators and encourages a long-term perspective for investors.
