For the better part of the last seven years, the stock market has been unstoppable. The benchmark S&P 500(SNPINDEX: ^GSPC) has gained at least 16% in six of the previous seven years, while the Dow Jones Industrial Average(DJINDICES: ^DJI) and Nasdaq Composite(NASDAQINDEX: ^IXIC) have both roared to several record highs.
Although catalysts have been plentiful — the artificial intelligence revolution, record S&P 500 share buybacks, and the Fed’s ongoing rate-easing cycle — headwinds are beginning to stack up for the stock market. The latest warning, courtesy of Wall Street professionals, points to the growing likelihood of trouble for stocks in the not-too-distant future.
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To preface the following discussion, keep in mind that all investors are fallible and no correlation is guaranteed to be accurate. If a data point or event existed that could forecast the future with 100% accuracy, every investor would be using it.
With the above being said, there’s no mistaking the skepticism institutional investors collectively have toward the Dow, S&P 500, and Nasdaq Composite at the moment.
According to data from Bank of America Securities, institutional investors sold a net of $8.3 billion of U.S. stocks for the week ending in Feb. 13, marking the second-largest weekly net sale of stocks in history. It was also the 13th time in 15 weeks that institutional investors sold more stocks than they purchased.
The catalyst behind this selling may be the historical priciness of equities. Whereas the S&P 500’s Shiller Price-to-Earnings (P/E) Ratio has averaged approximately 17.3 over the last 155 years, it’s spent the previous three months vacillating between 39 and 41. This is the second-priciest stock market in history, trailing only the dot-com bubble.
The previous five instances since January 1871 in which the Shiller P/E exceeded 30 were eventually followed by declines of at least 20% in the Dow, S&P 500, and/or Nasdaq Composite.
What’s more, the Federal Reserve is historically divided. The Federal Open Market Committee (FOMC) — the 12-person body, including the Fed chair, responsible for setting the nation’s monetary policy — has had dissents in opposite directions in two of the last three meetings.
Image source: Getty Images.
Based solely on institutional investors’ actions, sizable drawdowns are expected in the Dow Jones Industrial Average, S&P 500, and Nasdaq Composite. But this doesn’t mean investors should head for the hills.
Aside from the reality that Wall Street professionals aren’t always right, stock market downturns tend to be short-lived. Analysts at Bespoke Investment Group found that the average S&P 500 bear market decline (20% or greater) lasted just 286 calendar days, or about 9.5 months, over the last 96 years.
In comparison, the typical S&P 500 bull market since the start of the Great Depression in September 1929 has endured for 1,011 calendar days, or roughly two years and nine months.
This notable disparity between bull and bear markets demonstrates the power of patience on Wall Street. For long-term-minded investors, every meaningful downturn represents a buying opportunity.
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Bank of America is an advertising partner of Motley Fool Money. Sean Williams has positions in Bank of America. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
