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 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 advise investors to exercise caution when adding new positions.
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.
Another indicator, the University of Michigan index of current economic conditions, plunged to 52.3, the lowest reading since the series began in 1960. The low reading would typically signal a recession, but has not yet been confirmed by either tighter financial conditions or a fall in the S&P 500.
The Chicago Fed National Financial Conditions Index turned up to -0.515 but continues to signal loose monetary conditions, which support high stock prices.
The S&P 500 has not experienced a significant correction since April, and the 30-week Smoothed Momentum indicator continues to oscillate above zero.
Stock Pricing
Stock pricing eased slightly, to 98.32 percent from a new high of 98.66 percent last week, and 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 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 S&P 500 reached a new high of 3.28 times sales, compared to a long-term average of 1.80 times.
Conclusion
A record-low current economic conditions index and a record-high price-to-sales ratio for the S&P 500 both warn of instability ahead. Stock prices are supported by loose monetary conditions, but cannot hide the underlying economic fragility.
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.
