Wall Street has seen a bullish run for the past 18 months, with the Dow Jones Industrial Average, S&P 500, and Nasdaq Composite reaching unprecedented heights. Since early 2023, these major indexes have increased by 23%, 44%, and 71%, respectively. However, the market’s history suggests that stock prices do not continuously rise, implying that corrections and bear markets are an inevitable part of the investment cycle.
Currently, two historically reliable metrics indicate a looming significant downturn in the stock market. These metrics, which have been accurate for over 150 years when back-tested, suggest a substantial decline could be imminent for the Dow Jones, S&P 500, and Nasdaq Composite. This forecast has led to a critical reassessment of portfolios, prompting some investors to sell specific holdings in anticipation of a market drop.
Decrease in U.S. M2 Money Supply
The first concerning metric is the U.S. M2 money supply, which has notably decreased for the first time since the Great Depression. Economists closely monitor M2, which includes all cash, coins, demand deposits, money market accounts, savings accounts, and certificates of deposit under $100,000. Over the past ninety years, the M2 money supply has steadily increased, reflecting the capital needed for transactions in a growing U.S. economy.
However, since reaching a peak in April 2022, the M2 money supply has decreased by 3.49%, with a peak drop of over 4.7% year-over-year in late 2023. This is the first time it has declined by at least 2% from a peak since the Great Depression. Historically, such declines have been linked to economic depressions and high unemployment rates. Although there has been a slight rebound in the year-over-year M2 money supply, the overall decline suggests potential pressure on discretionary spending.
High Shiller P/E Ratio for the S&P 500
The second worrying metric is the Shiller price-to-earnings (P/E) ratio for the S&P 500, also known as the cyclically adjusted price-to-earnings ratio or CAPE ratio. This ratio is calculated using average inflation-adjusted earnings over the past ten years. Recently, the S&P 500’s Shiller P/E ratio ended at 35.76, just below its recent peak of around 37, and more than double the historical average of 17.14.
Historically, when the Shiller P/E ratio exceeds 30, it has preceded significant market downturns. Over the past 153 years, whenever the ratio has crossed this threshold, the S&P 500 and/or Dow Jones Industrial Average have eventually lost between 20% and 89% of their value. While the Shiller P/E ratio is not a precise timing tool, extended valuations are typically unsustainable in the long run. With the current ratio near 36, a substantial market correction appears likely.
Strategic Stock Sales Ahead of Anticipated Decline
In light of these warning signs, some investors have proactively adjusted their portfolios by selling off certain stocks. Three notable stocks sold in anticipation of the market decline are Intuitive Surgical, Vertex Pharmaceuticals, and ExxonMobil.
- Intuitive Surgical: Despite its robust performance and leading position in the robotic-assisted surgical systems market, the stock was sold due to its high valuation. Shares were trading at about 60 times forward-year earnings, deemed unsustainable.
- Vertex Pharmaceuticals: Known for its dominance in the cystic fibrosis treatment market, Vertex Pharmaceuticals was sold due to overvaluation. The stock was trading at 12 times current-year sales and 27 times forward-year earnings, fully pricing in its growth prospects.
- ExxonMobil: The oil and gas giant was sold due to its cyclical nature and high price-to-book value. Commodity-based businesses are prone to emotional swings, and a potential decline in crude oil demand could negatively impact ExxonMobil’s valuation.
These strategic moves were made to mitigate potential losses and to position for reentry into these stocks if their prices drop significantly. As the market prepares for a possible downturn, careful portfolio management remains essential for navigating uncertain times.
