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
We have revised the bull-bear market leading indicator to improve its responsiveness, stripping it down to a composite of five key indicators. At present, two of five indicators signal risk-off, indicating medium risk of a US bear market.
Freight Transport Activity
The plunging Cass Freight Shipments Index warns of contracting economic activity, signaling risk-off. The index highlights broad freight shipping levels in the mainstream economy, and a rise or fall of more than 3 basis points signals risk-on or risk-off, respectively.
Stock Pricing
US stock pricing increased to 96.17% from 95.96% last week, against a recent low of 91.79% six weeks ago.
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.
Buffett Indicator
Warren Buffett's favorite long-term measure of stock market valuation compares stock market capitalization to GDP, providing a stable, long-term ratio unaffected by fluctuating profit margins. The ratio reached a new high of 3.16 last week, more than double its long-term average of 1.2.
Dow Jones Industrials Price-to-Sales
The Price-to-Sales ratio for the Dow Jones Industrial Average has reached a new high of 4.10. We use a 20% trimmed mean of the Price-to-Sales ratio for the 30 stocks in the Dow to remove the most extreme readings that would otherwise distort the ratio.
Shiller CAPE
Robert Shiller's CAPE compares the S&P 500 index to its 10-year average of inflation-adjusted earnings, smoothing business-cycle distortions. The present peak of 40.4 is the second-highest in history, behind only the Dotcom bubble in 2000, and far above its long-term average of 22.4.
Conclusion
The Bull-Bear indicator suggests the US economy is slowing, but is not yet in a recession.
Extreme pricing, however, elevates 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
Managing Risk
To find out more, go to Managing Risk on the top menu, or see:
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.