Is the Stock Market Going to Crash in 2025? 2 Historically Flawless Indicators Paint a Clear Picture.
With just two trading days left before 2024 comes to a close, it’s fair to say this will be another successful year for Wall Street and everyday investors. The ageless Dow Jones Industrial Average (DJINDICES: ^DJI), benchmark S&P 500 (SNPINDEX: ^GSPC), and growth stock-inspired Nasdaq Composite (NASDAQINDEX: ^IXIC) have all reached multiple all-time highs this year and gained 15%, 27%, and 33% on a year-to-date basis, as of the closing bell on Dec. 24.
Numerous catalysts are responsible for lifting Wall Street’s tide, including:
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Stock-split euphoria.
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Better-than-anticipated corporate earnings.
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Aggressive share repurchase activity by the market’s most influential companies.
However, Wall Street is a forward-looking entity, and the shift to a new calendar year brings forth the age-old question: “Will stocks move higher in 2025?”
Although bull market rallies tend to stick around considerably longer than downturns, two historically flawless indicators foreshadow trouble for the stock market in the new year.
This valuation tool has forecast stock market declines of 20% to 89% over the last 154 years
Among the various forecasting tools and predictive metrics that point to potential trouble for Wall Street, arguably none is more worrisome than the S&P 500’s Shiller price-to-earnings (P/E) Ratio, which is also commonly referred to as the cyclically adjusted P/E Ratio (CAPE Ratio).
The most rudimentary of all valuation tools is the P/E ratio, which is calculated by dividing a company’s share price into its trailing-12-month earnings per share (EPS). This traditional valuation metric works great on time-tested companies but can be easily thrown off by economic shocks and growth stocks.
In comparison, the S&P 500’s Shiller P/E is based on average inflation-adjusted earnings over the previous 10 years. Accounting for a decade of EPS history ensures that a shock event, such as lockdowns during the early stages of the COVID-19 pandemic, won’t render this valuation metric ineffective.
On Dec. 24, the S&P 500’s Shiller P/E Ratio closed at 38.35, which is within striking distance of its yearly high of almost 39. For added context, this is more than double its average reading of 17.19 over the last 154 years and represents the third-highest reading during a continuous bull market since January 1871.
Here’s where things get interesting: There have been only six occurrences of the Shiller P/E surpassing 30 during a bull market rally in 154 years, including the present, and all five prior instances saw the Dow Jones Industrial Average, S&P 500, and/or Nasdaq Composite eventually lose between 20% and 89% of their value.
Although the Shiller P/E doesn’t tell investors when these declines will take place, it does have a flawless track record of being a harbinger of eventual big-time downside. In other words, it pretty clearly shows that outsized stock valuations aren’t well-tolerated over extended periods.
U.S. money supply hadn’t done this since the Great Depression — and it (historically) spells trouble
However, the Shiller P/E Ratio isn’t the only indicator that has a historically flawless track record of forecasting significant downside in the stock market. A move we haven’t witnessed in 90 years in U.S. money supply is an ominous warning, as well.
Though there are five measures of money supply, the two given the most credence are M1 and M2. The former factors in cash and coins in circulation, along with demand deposits in a checking account. Meanwhile, M2 takes everything into account from M1 and adds in savings accounts, money market accounts, and certificates of deposit (CD) below $100,000. It’s this latter money-supply measure, M2, which has raised red flags.