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 S&P 500 has crossed below its 50-week moving average, but has yet to test primary support at 6550. Twiggs Smoothed Momentum (30-week) is also declining but has yet to cross below zero, which would signal risk-off.
Also, the Chicago Fed National Financial Conditions Index rose to -0.514 last week. Financial conditions are tightening, but still some way from the -0.40 that would signal risk-off.
Stock Pricing
Stock pricing eased to 94.60 percent from 98.64 percent last week. The steep change is primarily due to a break in the series. We have replaced the Price-to-Sales ratio and Forward Price-Earnings Ratio for the S&P 500 with similar series for the Dow Jones Industrial Index. However, there is one notable difference: we use a 20% trimmed mean, which excludes the top 10% and bottom 10% of readings for individual stocks, to minimize distortion from outliers in the smaller index population of 30 stocks. The reading remains extreme, warning of a significant drawdown in stocks.
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 the stock market price measure is relative to the historical mean, the greater the risk of a sharp drawdown.
The Forward Price-to-Earnings Ratio for the Dow Jones Industrial Average (with a 20% trimmed mean) at 21.87 remains the highest over the past 7 years.
The Forward Price-to-Sales Ratio for the Dow Jones Industrial 30 (with 20% trimmed mean) remains below its 2021 and 2022 readings of 3.96 and 3.99, respectively.
Conclusion
The bull-bear indicator at 40% warns of a bear market ahead, while extreme price levels indicate an elevated 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.
