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
The Bull/Bear indicator remains at 40%, warning of a bear market ahead, with three of five indicators signaling risk-off.
The National Financial Conditions Index from the Chicago Fed eased to -0.59, indicating loose financial conditions similar to 2021, but Bitcoin’s fall below $90,000 warns that investors are shifting to risk-off.
Stock Pricing
Stock pricing eased to 98.15 percent from 98.20 percent last week, but remains close to the October high of 98.66, compared with a low of 95.04 percent in April. 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 stock market prices are relative to their historical mean, the greater the risk of a sharp drawdown.
Warren Buffett’s favorite measure of stock market valuations is stock market capitalization to GDP. The current record high of 3.08 is at a considerable premium to the Dotcom bubble peak at 1.89 and the 50-year average of 1.20.
Robert Shiller’s CAPE ratio compares the current S&P 500 index to the preceding 10 years of inflation-adjusted earnings. The current value of 40.09 is only the second time in more than a century that the ratio has crossed above 40. The first time was during the Dotcom bubble in 1999-2000. The average over the past 50 years is 22.3.
Conclusion
The bull-bear indicator at 40% warns of a bear market ahead, while extreme price levels increase 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
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.
