The gauge on the left indicates whether the market is in a bull or bear phase, and the indicator on the right reflects the current stock market valuation. Stock market pricing indicates whether stocks are cheap or expensive in relation to earnings, but it is a poor indicator of market timing. We do not recommend selling stocks because market valuations are high; however, we recommend exercising caution when adding new positions.
Bull/Bear Market
The Bull/Bear indicator remains at 40%, warning of a bear market ahead. One labor market data indicator (highlighted in orange below) remains delayed due to the recent U.S. government shutdown.
Continued unemployment claims declined to 1.838 million, seasonally adjusted. No explanation was provided for the sharp fall, with Wolf Richter attributing it to problems with seasonal adjustments and the holiday season. Unadjusted data show a similar decline in the last week but a year-on-year increase of 43K (2.5%).
The Chicago Fed National Financial Conditions Index declined -0.546 on December 5, indicating loose monetary conditions that support high stock prices.
However, Bitcoin is still testing support at 90,000. The cryptocurrency provides an up-to-date view of liquidity, and a fall below 85,000 would warn of another financial market contraction.
Stock Pricing
Stock pricing eased slightly to 98.48 percent from 98.55 percent last week, compared to a high of 98.66 percent in late October and a low of 95.04 percent in April. The extreme pricing warns that stocks are at risk of a significant drawdown.
We use z-scores to measure each indicator’s current position relative to its historical data, with results expressed in standard deviations from the mean. We then calculate an average of the five readings and convert that to a percentile. The higher stock market prices are relative to their historical mean, the greater the risk of a sharp drawdown.
Conclusion
The bull-bear indicator at 40% signals a bear market ahead, while extreme price levels increase the risk of a significant drawdown.
Acknowledgments
- Prof. Robert Shiller: CAPE 10 Data
- S&P Global: S&P 500 Sales and Earnings Estimates
- University of Michigan: Survey of Consumers
- Federal Reserve of St Louis: FRED Data
- Bureau for Economic Analysis: Motor Vehicles Data
Notes
- See Managing Risk to learn more.
- See Bull-Bear and Stock Valuation for more on our composite market indicators.
Colin Twiggs is a former investment banker with almost 40 years of experience in financial markets. He co-founded Incredible Charts and writes the popular Trading Diary and Patient Investor newsletters.
Using a top-down approach, Colin identifies key macro trends in the global economy before evaluating selected opportunities using a combination of fundamental and technical analysis.
Focusing on interest rates and financial market liquidity as primary drivers of the economic cycle, he warned of the 2008/2009 and 2020 bear markets well ahead of actual events.
He founded PVT Capital (AFSL No. 546090) in May 2023, which offers investment strategy and advice to wholesale clients.