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%, signaling a bear market ahead. Two market indicators (marked in orange below) are delayed due to the recent US government shutdown.
The Chicago Fed National Financial Conditions Index eased to -0.534 on November 21, indicating loose monetary conditions that support high stock prices.
However, a steep plunge in Bitcoin warned of a liquidity contraction during the government shutdown.
The Treasury General Account at the Fed increased during the government shutdown, removing liquidity from financial markets. We expect liquidity to improve as the TGA balance declines in December.
Continued unemployment claims are close to 2 million, while the unemployment rate rose to 4.4%. Rising claims above 2 million typically forewarn of a recession, but an unemployment rate below 5.0% is not generally associated with recessions.
Stock Pricing
Stock pricing increased to 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.
Robert Shiller’s CAPE has climbed above 40 for the second time in its more than one hundred-year history. The first time was during the 1999-2000 Dotcom bubble. CAPE compares the S&P 500 index to its 10-year inflation-adjusted history. The average since 1974 is 22.25.
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.
