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 valuation of the stock market. 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, with three of five indicators signaling risk-off.
University of Michigan’s Index of Current Economic Conditions remains near its record low, warning of a recession.
However, the Chicago Fed National Financial Conditions Index has yet to confirm the bear signal. Financial conditions tightened to -0.475 on March 20; a rise above -0.40 would confirm the risk-off signal.
Stock Pricing
Stock pricing eased slightly to 92.26 percent from 92.37 percent last week. The steep change from 98.64 three weeks ago is partly attributable to a break in the series. We replaced the S&P 500 Price-to-Sales ratio and Forward Price-Earnings Ratio with similar series for the Dow Jones Industrial Index. There is one notable difference: we use a 20% trimmed mean, which excludes the top 10% and bottom 10% of readings for individual stocks, to minimize distortion from outliers in the smaller population of 30 stocks. The reading remains extreme, warning 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 the stock market price measure is relative to the historical mean, the greater the risk of a sharp drawdown.
The S&P 500 PE, measured against the highest trailing earnings, retreated sharply as equity markets shifted to risk-off.
Robert Shiller’s long-term CAPE index has also retreated. CAPE compares the current S&P 500 value to its 10-year average of inflation-adjusted earnings.
Conclusion
The bull-bear indicator at 40% warns of a bear market, while extreme pricing highlights 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.