Where will US markets find their bottom? A model points to a potential 11% drop
Dr. Gil Bufman’s economic model suggests the S&P 500 and Nasdaq may decline further before rebounding.
How much further will the U.S. markets fall, and where will the bottom be found from which the rise will begin? This seems to be one of the key questions, if not the main question, preoccupying investors around the world in general and in the U.S. in particular, since it is Wall Street that provides the directional reading for markets globally.
No one has a crystal ball—and it is worth being cautious of those who claim to have one—but according to a model developed 26 years ago by Dr. Gil Bufman, an economic consultant, macroeconomic expert, and until recently the chief economist of Bank Leumi, it can be estimated that the main indices in the U.S. could fall another 8%-11% before they reach the bottom.
Bufman’s model estimates the level of fragility in the stock market. It does not identify triggers for declines but rather indicates the point at which a significant drop is likely to occur. He calls this ratio the macroeconomic multiplier.
This multiplier estimates the ratio between the total value of all companies on the New York Stock Exchange (NYSE)—which, in Bufman’s view, best represents the American economy because it includes 2,000 companies across various sectors and is equally weighted, preventing a few tech giants from dominating the index—and nominal U.S. GDP, which measures the level of economic activity in the world’s largest economy.
The ratio between these variables creates a kind of macroeconomic multiple, expressing the extent to which stock prices are expensive relative to economic activity. The higher the ratio, the more fragile the market.
According to historical data, when the ratio between the NYSE index and U.S. GDP reaches approximately 0.64 or higher, the index enters a "hot zone," signaling an increased likelihood of a market correction.
This ratio is not absolute but a moving average over the past 15 years, and reaching 0.64 represents the historical average plus one standard deviation. Simply put, when the market value of companies becomes significantly inflated relative to GDP, warning signs emerge.
We have seen this pattern time and time again since the mid-1990s. Every major market decline occurred after this ratio reached a critical threshold. "We saw this before the dot-com bust in the early 2000s, before the great global crisis of 2008, and also in the first quarter of 2018, when the ratio came very close to this point and signaled the falls in the markets in the last third of 2018.
"We also reached such a point in the estimate made in early January 2020, before the coronavirus broke out, and also at the end of 2021, when the ratio touched the limit. We saw a decrease of about 30% in the Nasdaq index in the following two quarters," says Bufman.
As of today, based on the latest GDP data released, valid for the fourth quarter of 2024, the ratio stands at 0.66 and began to rise from the second half of 2024.
According to Bufman, “This has created a situation of thin ice. When you walk gently on thin ice, there is a better chance that it will not crack. But when you walk roughly on it, the risk of it breaking is much more significant, and that seems to be what is happening now.”
By this, Bufman is referring to U.S. President Donald Trump. In other words, the U.S. stock market has already entered the critical zone, making it sensitive to shocks, and Trump seems to be providing plenty of them in the form of uncertainty that he is introducing into the market, given the series of moves he has announced since re-entering the White House. And so, since the beginning of the year, the S&P 500, the flagship American index, has fallen by 4.5%, and the Nasdaq has fallen by 8.4%.
How does Bufman derive from the model the rate of decline currently expected in the American indices until they reach the bottom? From past experience and in terms of data, according to the model, of the landslide that occurred in 2018, which his model warned about.
"Even then, the U.S. president was Trump, although he was in his first term, which may have contributed to his being more restrained," says Bufman. In December 2018, the S&P 500 index fell by 9%. This was against the backdrop of interest rate hikes by the Federal Reserve, which raised fears of an economic slowdown.
Then, as now, Trump was engaged in a trade war with China, which raised uncertainty about global growth and damaged investor confidence. Market volatility was also high due to budget disputes in the U.S. government, which is still happening today.
The combination of high interest rates, geopolitical risks, a trade war, and fears of a recession led to the sharp declines. Sounds familiar, right?
From the declines on the NYSE, we can deduce further declines of 8% in the S&P 500 index and another 11% drop in the Nasdaq index. “If Trump’s policy measures are more severe than expected, the decline could be more significant,” says Bufman. He also outlines a scenario in which the trend could change and the market could start to rise before reaching the bottom: “It depends on a significant reduction in corporate taxes in the U.S., the provision of sectoral benefits, and a relaxation in the trade war.”
Bufman also tested his model on the German stock market, using its flagship index, the DAX, and the model indicates that the ratio in the German market is low. In other words, the price of German companies is cheap in relation to the economic activity they generate. According to the model, the German market has the potential to rise by about 20%, after rising by 13% since the beginning of the year (i.e., another 7%).
The German market is supported by low multiples at which companies are traded, as well as by the fiscal change led by incoming Chancellor Friedrich Merz, who plans to remove the strict debt limit in order to invest 600 billion euros in armaments over the next decade.
This is in light of the understanding that is permeating Europe that it is not possible to rely on the U.S. due to the cold shoulder that Trump is turning to Ukraine while getting closer to Russia. Such a shift would bring Germany's defense budget to 2.5% of GDP, up from 1.5% today.
A significant infusion of money into defense is providing a boost to German industry, which is the sector that leads the German stock market. Germany's civilian spending is also expected to grow, and the government plans to invest 500 billion euros in infrastructure such as public transportation, hospitals, and energy.
