The gauge on the left indicates whether the market is in a bull or bear phase, and the one on the right reflects the current stock market valuation levels. 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 the market valuation is 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. Labor market data (marked in orange below) is delayed due to the recent US government shutdown.
Heavy truck sales warn of a recession, with a steep decline to 27,900 units in November and the 3-month moving average falling to 35,400.
The University of Michigan index of current economic conditions is at a record low since the survey started in 1960, with the 3-month moving average plunging to 53.5 in November.
However, a low reading for the index of current economic conditions requires confirmation from the Chicago Fed National Financial Conditions Index or the S&P 500 Smoothed Momentum (30-week).
The Chicago Fed National Financial Conditions Index increased to -0.524 on November 28, indicating that monetary conditions remain loose, supporting high stock prices.
A steep plunge in Bitcoin last week warned of a liquidity contraction, but that seems to be easing.
The Treasury General Account at the Fed is still high. This removes liquidity from financial markets, but we expect a decline in December.
Stock Pricing
Stock pricing is unchanged at 98.55 percent, compared to a high of 98.66 percent in late October and an April low of 95.04 percent. 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 that stock market pricing is relative to its historical mean, the greater the risk of a sharp drawdown.
The Forward PE of the S&P 500 remains high at 25.2 times projected earnings, above its long-term average of 16.1.
Conclusion
The bull-bear indicator at 40% warns of a bear market ahead, while extreme pricing increases the long-term 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.