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 US government shutdown.
Employment in cyclical sectors has declined by 111,000 from its February peak of 27,824,000. A decline of 300,000 would trigger a recession warning. Cyclical sectors — Manufacturing, Construction, Transportation, and Warehousing — account for less than 20% of the total workforce but typically experience most job losses during a recession.
The University of Michigan consumer survey reported the lowest index value ever recorded for current economic conditions since the survey began in 1960.
However, the stock market remains buoyant and has not yet confirmed the bear signal.
Stock Pricing
Stock pricing increased slightly to 98.50 percent from 98.48 percent last week, close to its high of 98.66 percent in late October and well above the 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.
The S&P 500 Forward Price-Earnings ratio is at 25.0, compared to the historic high of 28.0 during the Dotcom bubble and a 50-year moving average of 16.3. Before the 1999/2000 Dotcom bubble, the forward PE had never risen above 20.0 over the preceding century.
Conclusion
The bull-bear indicator at 40% signals a bear market ahead, while the extreme pricing increases 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.