One of the great things about economics is that it’s all about numbers. This gives us much to track and, if we’re smart, many warnrnings to see. And right now, there’s just one question on all our minds:
When do we get out of the market?
Phrased another way: How can we know the market’s peaked and the crash is imminent?
It boils down to the usual question of timing.
If we could time the market perfectly, we’d all be rich!
Obviously, perfect timing is a fool’s game. So instead, we make the best educated forecast we can, using these seven signs to let us know when the market is peaking and it’s time to cover our asse(t)s…
Indicator #1: Margin debt reaches (or exceeds) $430 million.
That’s how high it got at the peak of the 2007 bubble. Since it has gone higher with each bubble peak since 2000, $470 million or a bit higher would be the number I would be looking for.
Indicator #2: Stock buybacks move closer to 87%.
Taking advantage of record-low interest rates, companies have been aggressively repurchasing their own shares. In doing so, they’ve artificially increased their earnrnings per share by 40%. Currently, 83% of S&P 500 companies are buying back their own stock. Before the 2007 peak, that number was at 87%. We’re close.
Indicator #3: Corporate profit as a percentage of GDP goes above 11%.
At the current level of 11%, corporate profit as a percentage of GDP is already at the highest ever, exceeding even the extreme 2000 bubble. We have the Fed keeping short-term interest rates near zero for so long to thank for that.
Indicator #4: Cyclically adjusted price-to-earnrnings ratios reach 24 to 27.
Excluding the extreme bubble of 2000 and 1929 — when P/Es topped out at 45 and 32, respectively — most major stock peaks occur between P/Es of 22 and 27. Before the correction in January, we hit 25. That is already high enough for a top.
Indicator #5: The market value of non-financial stocks, divided by the GDP ratio, rises above 1.3.
During major peaks, the ratio of market value of non-financial stocks divided by GDP tends to range between 1 and 1.5. We’ve already hit 1.3. That’s high enough, but higher would be better.
Indicator #6: The S&P price-to-revenue valuation fluctuates between -3% and 1%.
Right now, the S&P price-to-revenue valuation model is higher than it was at the peak in 1968. It’s near 2007 levels and approaching the highs of 2000.
Indicator #7: 62% bulls versus 20% bears.
The American Association of Individual Investors tracks the dumb money and everyday investors. These people got shocked out of the market after the 2008 crash. But after nearly five years of Fed stimulus and market increases, these investors began returnrning to the market in 2012.
What you’ll see just before a major top is a market where bulls rule at around 62%, while bears are only about 20%. We reached those levels before the last top, in late 2010. We didn’t reach those levels before the correction in January. However, we did see extreme readings for investment advisors at 62% bullish and 14% bearish. These professionals are more “in the market” and not as shell-shocked as everyday investors. Hence, they may be the better measure.
Those subscribed to my Boom & Bust newsletter will receive an alert from me as soon as I’m convinced we’ve hit that peak, with instructions on what to do. If you’re not yet a subscriber, I urge you to join today.
P.S. I must warnrn that we should be skeptical of all major indicators in the market nowadays, because the Fed and central banks have manipulated everything so thoroughly. As a result, no indicator works as well as it did before. That sucks, but it’s not the end of the world. Indicators can still offer us warnrnings, where before we’d have seen none. Just stay flexible.
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Ahead of the Curve with Adam O’Dell
History can be an excellent guide for spotting major turnrns in the market. Naturally, the market and indicator levels we saw in 2006 and 2007 are firmly etched on our charts, now serving as key levels to watch.