Is the Stock Market Correction Over? A Flawless Forecasting Tool With Over 150 Years of Data Weighs In.

Over the last month, Wall Street has reminded professional and everyday investors that stocks don't, in fact, move up in a straight line.

Since the closing bell on Feb. 19, the iconic Dow Jones Industrial Average (DJINDICES: ^DJI), broad-based S&P 500 (SNPINDEX: ^GSPC), and innovation-inspired Nasdaq Composite (NASDAQINDEX: ^IXIC) have respectively shed 6%, 7.8%, and 11.8% of their value as of March 20. To add, the S&P 500 and Nasdaq Composite declined by at least 10% from their all-time highs, which placed both indexes in official correction territory (as of March 13).

Where to invest $1,000 right now? Our analyst team just revealed what they believe are the 10 best stocks to buy right now. Learn More »

However, none of these three major stock indexes have fallen below their respective March 13 closing lows, which begs the question: Is the stock market correction already over for the S&P 500 and Nasdaq Composite, or is Wall Street simply clearing its throat ahead of a steeper decline?

To answer this question, let's turn to a forecasting tool that has over 150 years of data in its sails.

Image source: Getty Images.

Wall Street's stock market correction may be just getting started

Prior to the latest stock market correction, there were quite a few predictive indicators and events that portended trouble. Examples include the first notable decline in U.S. M2 money supply since the Great Depression; the longest yield curve inversion in history, which coincided with the steepest inversion in four decades; and most recently, the Federal Reserve Bank of Atlanta's GDPNow forecast calling for a 1.8% contraction in U.S. first-quarter gross domestic product (GDP).

But the one forecasting tool that has a flawless track record of foreshadowing sizable directional moves in the Dow Jones Industrial Average, S&P 500, and Nasdaq Composite is the Shiller price-to-earnings (P/E) ratio, which is also referred to as the cyclically adjusted P/E ratio, or CAPE ratio.

When investors think of valuation tools, the standard P/E ratio likely comes to mind. A company's P/E ratio is arrived at by dividing its share price by its trailing-12-month earnings per share (EPS). The traditional P/E ratio is a handy tool for quickly evaluating mature businesses, but it isn't particularly useful during recessions or when shock events occur.

In comparison, the S&P 500's Shiller P/E ratio is based on average inflation-adjusted EPS over the previous 10 years. Utilizing a decade's worth of EPS data ensures that shock events can't skew the reading, and it provides for apples-to-apples valuation comparisons when back-tested more than 150 years.

S&P 500 Shiller CAPE Ratio data by YCharts. CAPE Ratio = cyclically adjusted P/E ratio.

In December, the Shiller P/E ratio hit a high reading of 38.89 during the current bull market cycle. For context, this reading is more than double its average multiple of 17.22 when back-tested to January 1871. As of March 20, the stock market correction had pushed the Shiller P/E down to 35.38.

What's noteworthy about the S&P 500's Shiller P/E isn't necessarily how far above its historic mean the current reading is, so much as how Wall Street's major stock indexes have eventually responded when this valuation tool topped 30 and stayed there for at least two months.

When back-tested 154 years, there are six instances, including the present, where the Shiller P/E ratio surpassed 30. Following each of the previous five occurrences, the S&P 500, Dow, and/or Nasdaq shed between 20% and 89% of their respective values. In other words, premium valuations haven't proved sustainable over long periods at any point in more than 150 years.

Although the S&P 500's Shiller P/E can't tell investors when a stock market correction will begin or how long it'll last, it does have a flawless track record of eventually foreshadowing a 20% (or greater) decline in Wall Street's major indexes. Based on a confluence of factors, of which the Shiller P/E sits atop, Wall Street's stock market correction may be just getting started.

Image source: Getty Images.

Putting stock market corrections into perspective

While stock market corrections that see the Dow Jones, S&P 500, and Nasdaq Composite take the elevator lower aren't for everyone, they're a normal and unavoidable aspect of the investing cycle.

According to data aggregated by market insights firm Yardeni Research, there have been 40 double-digit percentage corrections in the benchmark S&P 500 since 1950, including the latest 10.1% decline. Running the math, this works out to a correction occurring, on average, every 1.88 years. With investor emotions shifting at the drop of a dime on Wall Street, no amount of fiscal and monetary policy can stop these double-digit declines from cropping up every now and then.

But perspective changes everything for investors. The ability to take a step back and look at things with a wider lens can completely alter the picture.

In June 2023, analysts at Bespoke Investment Group published a data set on X that compared the length of every bull and bear market for the S&P 500 dating back to the start of the Great Depression (September 1929). What it highlighted is the nonlinearity of investing cycles.

Since the Great Depression, the average S&P 500 bear market has lasted just 286 calendar days, which equates to about 9.5 months. Furthermore, only nine out of 27 bear markets stuck around for at least one year.

It's official. A new bull market is confirmed.

The S&P 500 is now up 20% from its 10/12/22 closing low. The prior bear market saw the index fall 25.4% over 282 days.

Read more at https://t.co/H4p1RcpfIn. pic.twitter.com/tnRz1wdonp

-- Bespoke (@bespokeinvest) June 8, 2023

On the other hand, the typical bull market has endured for 3.5 times as long -- 1,011 calendar days -- with a third of these bull markets continuing for between 1,324 calendar days and 4,494 calendar days. Uptrends in the Dow Jones, S&P 500, and Nasdaq Composite last substantially longer than stock market corrections and bear markets.

The power of time and perspective is further enhanced thanks to a recently updated data set from Crestmont Research. This data set depicts the total 20-year annualized rolling returns (including dividends) of the S&P 500 dating back to the start of the 20th century.

Crestmont's data set produced 106 rolling 20-year periods (1900-1919, 1901-1920, and so on, to 2005-2024) of total return data. What's of note is that all 106 timelines produced a positive annualized return. This is to say that, hypothetically, if an investor had purchased an S&P 500 index fund at any point since 1900 and simply held their position for 20 years, they'd have generated a profit, inclusive of dividends, every time.

Even though stock market corrections (and the prospect of them steepening) may be worrisome over short periods, every downturn in the Dow Jones, S&P 500, and Nasdaq Composite has been a surefire buying opportunity for well over a century.

Should you invest $1,000 in S&P 500 Index right now?

Before you buy stock in S&P 500 Index, consider this:

The Motley Fool Stock Advisor analyst team just identified what they believe are the 10 best stocks for investors to buy now… and S&P 500 Index wasn’t one of them. The 10 stocks that made the cut could produce monster returns in the coming years.

Consider when Nvidia made this list on April 15, 2005... if you invested $1,000 at the time of our recommendation, you’d have $721,394!*

Stock Advisor provides investors with an easy-to-follow blueprint for success, including guidance on building a portfolio, regular updates from analysts, and two new stock picks each month. The Stock Advisor service has more than quadrupled the return of S&P 500 since 2002*. Don’t miss out on the latest top 10 list, available when you join Stock Advisor.

See the 10 stocks »

*Stock Advisor returns as of March 18, 2025

Sean Williams has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.