The gauge on the left indicates bull or bear market status, and the one on the right reflects stock market valuation levels. Stock market pricing indicates whether stocks are cheap or expensive relative to earnings, but it is a poor indicator of market timing. We do not recommend selling stocks because the market valuation is high. Still, we would advise investors to be circumspect about adding new positions without carefully investigating the underlying value.
Bull/Bear Market
The Bull/Bear indicator remains at 40%, warning of a bear market ahead. Updates to three market indicators (highlighted in orange below) are delayed because of the US government shutdown.
The Philadelphia Fed Coincident Economic Activity Index deserves mention in the absence of updates for some of our regular indicators. A decline below 2.5% typically only occurs several months ahead of a recession.
The Chicago Fed National Financial Conditions Index continues to signal loose monetary conditions, supporting high stock prices.
However, a decline in bank reserves below $3.0 trillion warns that repo markets are tightening.
And Bitcoin continues to test support at 110K, warning of tighter liquidity.
Stock Pricing
Stock pricing increased to a new high of 98.66 percent, compared to an April low of 95.04 percent. The extreme reading warns that stocks are at risk of a significant drawdown.
We use z-scores to measure each indicator’s current position relative to its history, with the result expressed in standard deviations from the mean. We then calculate an average for 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 index climbed above 40 for the first time ever outside of the Dotcom bubble. CAPE compares the S&P 500 index to a ten-year average of inflation-adjusted earnings.
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.
