A 32-year market vet warns the S&P 500 is set to fall 50%-70% in the years ahead with valuations at historic highs — and says that an imminently weakening labor market will be the catalyst for the crash (2024)

There are many ways to measure valuation levels in the overall market. Wolfenbarger, the founder of investing newsletter BullAndBearProfits.com and a former investment banker at JPMorgan and Merrill Lynch, cites John Hussman's ratio of the market cap of all non-financial stocks to the gross value added of those stocks. Hussman says it's the most accurate indicator of future market returns that he's found.

Right now, the metric shows -5% returns annually over the next 12 years. In the chart below, the valuation measure is shown in blue and is inverted, and actual subsequent S&P 500 returns are shown in red.

Other valuation measures are also hovering at historically high levels. The so-called Warren Buffett indicator of total market cap-to-GDP well exceeds dot-com bubble levels and is reapproaching its 2022 highs. And, the Shiller cyclically-adjusted price-to-earnings ratio is above 1929 levels and trails levels only seen in 1999 and 2021.

Based on historical long-term returns when valuations are this high, Wolfenbarger said that the S&P 500 is likely to suffer a long and drawn-out sell-off. By the bottom of the market cycle, the index will have likely fallen 50%-70%, he said.

While it sounds like a doomsday call, it's important to remember that these kinds of scenarios have in fact played out in recent decades. Stocks took two years to bottom when they crashed almost 50% after the dot-com bubble. They took a year-and-a-half from peak-to-trough in the Great Financial Crisis. And nine years following the dot-com bubble peak in 2000, the S&P 500 was still down about 50%.

Why will stocks crash?

Valuations by themselves aren't typically a good enough catalyst for a stock-market sell-off. Another look at the Bank of America chart above shows they matter very little in the short term.

A sufficient catalyst, Woflenbarger said, is weakening in the labor market and a subsequent recession, which he believes is about to unfold.

Wolfenbarger shared with Business Insider multiple indicators he's watching that show the unemployment rate could rise in the months ahead.

The first is the National Federation of Independent Business' hiring plans index. Its three-month moving average has surged, indicating the unemployment rate could soon follow.

Second, The Conference Board's Employment Trends Index (in blue) has declined in recent years. Historically, this has meant trouble for total non-farm employment in the US, which has not yet unfolded.

Third, the number of US states with a rising unemployment rate is spiking, meaning that the overall unemployment rate should see further upside.

And fourth, about five quarters after the US Treasury yield curve inverts (using the 10-year and 2-year durations), unemployment has historically started to tick up. April will mark the start of the sixth quarter since the yield curve officially inverted, which according to the indicator's founder, Cam Harvey, is when the curve stays inverted for a duration of three months.

The US unemployment rate is already on a slight uptrend, having climbed from 3.4% in April 2023 to 3.9% as of February. According to the Sahm Rule, named after former Fed economist Claudia Sahm, once the three-month moving average of the unemployment rate moves up by 0.5% from its low over the previous 12 months, the US economy is in a recession in real time. The indicator has a perfect track record of identifying downturns. Today, it sits at 0.27.

Wolfenbarger's views in context

Wolfenbarger's stock market call is on the more extreme end of Wall Street outlooks. Fellow market bears Jeremy Grantham, John Hussman, and David Rosenberg have all stuck to their significant downside expectations. But most top strategists at major banks see limited downside from here, if any at all. Many, including Goldman Sachs' David Kostin and Bank of America's Savita Subramanian, have had to revise upward their 2024 targets already this year.

Wolfenbarger's recession call is also out of consensus these days, with many bearish forecasters abandoning their downbeat outlooks. But many see slower growth and a softening labor market going forward, even if that doesn't mean an outright recession.

This week, Pantheon Macroeconomics Founder and Chief Economist Ian Shepherdson laid out several reasons he sees unemployment ticking up in the coming months.

For example, layoffs are rising, which is usually followed by rising unemployment claims.

"For the first time in this cycle, an array of indicators point tentatively to a meaningful slowdown in economic growth, driven by the consumer, and a clear weakening in the labor market, as soon as the second quarter," Shepherdson said in a client note.

For now, however, bad data simply hasn't shown up yet, and bulls have ridden the wave to all-time highs — a trend that could very well continue. Only time will tell how Wolfenbarger's forecasts hold up in the near- and long-terms.