
The past few weeks have served as a good reminder that the stock market wouldn’t be a “market” unless equities were able to move in both directions. While uptrends have handily outlasted downdrafts spanning more than a century, it’s the emotion-driven moves lower that tend to garner all the attention.
On Monday, March 10, all three of Wall Street’s major stock indexes struggled mightily. The ageless Dow Jones Industrial Average (DJINDICES: ^DJI), benchmark S&P 500 (SNPINDEX: ^GSPC), and innovation-powered Nasdaq Composite (NASDAQINDEX: ^IXIC) respectively lost 890, 156, and 728 points. This represented the Nasdaq’s third-largest daily point loss in its storied history, and marked the S&P 500’s ninth-biggest single-session point decline.
These moves lower are even more dramatic when compared to their recent all-time closing highs. As of the closing bell on March 10, the Dow Jones and S&P 500 were 6.9% and 8.6% below their respective closing peaks, while the Nasdaq Composite was firmly in correction territory, with a loss of 13.4%. Nearly the entirety of the Nasdaq’s decline has occurred in a 13-session stretch.
Although there’s no way to know ahead of time precisely when the stock market will plunge, how long a decline will last, or where the bottom will be, historic precedent does tend to offer clues for investors.
Based on one historically flawless valuation indicator, which has been back-tested more than 150 years, there’s a relatively clear downside target for the Dow Jones Industrial Average, S&P 500, and Nasdaq Composite.
There have been a couple of warning signs leading up to the stock market’s plunge over the last three weeks. For instance, the Federal Reserve Bank of Atlanta is expecting the U.S. economy to contract during the first quarter at the fastest rate since 2009, excluding the years impacted by COVID-19. Likewise, a historic decline in U.S. money supply in 2023 — the first since the Great Depression — portended trouble for the U.S. economy and Wall Street.
But the most-prevailing of all concerns is a valuation tool with an immaculate history of foreshadowing downside for the stock market.
When most investors think about measuring value, the traditional price-to-earnings (P/E) ratio probably comes to mind. The P/E ratio, which is arrived at by dividing a company’s share price by its trailing-12-month earnings per share, can be quite useful in quickly evaluating mature businesses. But its utility goes out the door when assessing growth stocks or during shock events/recessions.