The Value Line Median Appreciation Potential has a good record forecasting smaller stocks' returns. And the next four years look bearish.

Small and mid-cap stocks are facing bearish indicators.

Smaller stocks will face stiff headwinds over the next four years.

That's a dispiriting prospect, since smaller stocks have already suffered a lot since hitting a high earlier this year. The Russell 2000 index RUT of smaller stocks is more than 10% below the high it set in mid-August, for example. Furthermore, nearly 40% of stocks in the S&P 500 are in bear-market territory, as measured by being at least 20% below their respective highs.

The reason to expect these stocks to continue suffering is a little-known indicator known as the Value Line Median Appreciation Potential (VLMAP). It reflects the median of the projections made by the analysts at Value Line (VALU) of where the 1,700 stocks they follow will be trading in three to five years' time. Though the VLMAP shows little ability to forecast the subsequent four-year returns of the S&P 500 SPX, it has an impressive track record when it comes to the Russell 2000 index of smaller- and mid-cap stocks - as you can see from the accompanying chart.

To appreciate the strength of its track record in this regard, consider a statistic known as the r-squared. It measures the degree to which the VLMAP predicts subsequent four-year returns. In the case of the S&P 500, VLMAP's r-squared is a statistically insignificant 0.8%, but it is 20.5% for the Russell 2000.

I last wrote about the VLMAP in November 2024. I quoted Dan Seiver, who at the time was very bearish on small- and mid-cap stocks. Seiver is editor of the PAD System Report and an emeritus economics professor at Miami University (Ohio) and a member of the economics faculty at Cal Poly University. Though the big drop Seiver was anticipating hasn't materialized, it is worth noting the Russell 2000's return since then (6.2% annualized) is less than half that of the S&P 500 (13.7% annualized).

In any case, two years remain in the VLMAP's implicit forecast at the time of that column, and Seiver's bearish forecast could still very much work out. In an email earlier this week, he said that because the VLMAP remains low by historical standards, he is "sticking to my guns... and am still holding a lot of cash reserves."

(Full disclosure note: Seiver's newsletter is not one of those that pay a flat fee to my performance-auditing firm to calculate its investment returns.)

Status of other valuation indicators

The VLMAP's track record is not only statistically significant, its r-squared is higher than some of the valuation indicators on which I periodically report in this column. I therefore am adding the VLMAP to that list, which appears below. Each of the indicators in that list was chosen because of its statistically significant record predicting the stock market's longer-term return.

As you can see from the table, these indicators are telling a very bearish story. Ironically, though VLMAP is relatively low (and bearish), many of the other indicators are even more bearish.

Mark Hulbert is a regular contributor to MarketWatch.

-Mark Hulbert