US Market Snapshot

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.

Stock Pricing

US stock pricing jumped to a new high of 97.22, up from 95.72 percent last week, and compared to the recent low of 91.79 twelve 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 provides a stable valuation ratio largely unaffected by fluctuating profit margins. The ratio of stock market capitalization to GDP jumped to a new high of 3.31, up from 3.25 last week. The ratio is way above its long-term average of 1.2 and warns that stock pricing is dangerously high.

Dow Jones Industrials Price-to-Sales

The Price-to-Sales ratio for the Dow Jones Industrial Average rocketed to 4.57, up from 4.21 last week. However, the index composition has changed, with Alphabet Inc. (GOOGL) replacing Verizon (VZ) on June 29. We use a 20% trimmed mean of the Price-to-Sales ratio across the 30 stocks in the Dow to remove the most extreme readings that would otherwise distort the ratio.

Shiller CAPE

Robert Shiller's CAPE smoothes out business-cycle effects by comparing the S&P 500 index to a 10-year average of inflation-adjusted earnings. The CAPE ratio retreated to 39.46, down from the recent peak of 41.33 five weeks ago. The current advance is the second-highest in history, behind only the Dotcom bubble in 1999-2000, with values far above their long-term average of 22.4.

Conclusion

The Bull-Bear indicator suggests the US economy is slowing, but is not yet in a recession.

Pricing is growing more extreme, however, increasing 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:

• US Bull-Bear Market Leading Indicator
• US Stock Market Pricing

Colin Twiggs

Colin Twiggs is a former investment banker with almost 40 years of experience in financial markets. He founded PVT Capital (AFSL number 546090), which provides income and growth strategies to wholesale clients.

Colin also co-founded Incredible Charts and writes the popular Patient Investor newsletter.

Using a top-down approach, Colin identifies macro trends in the global economy and then combines fundamental and technical analysis to evaluate opportunities in sectors that stand to benefit.

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.