USA TODAY International Edition
Bear market warnings signs
As Wall Street’s bull turns 8 this week, now’s the time to seek signs of a peak
Wall Street pros say bull markets don’t die of old age. But after eight years of rising stock prices, being on the lookout for signs of a market peak makes good financial sense.
No bull lasts forever. Good times eventually are followed by bad, as investor euphoria gives way to fear. The performance history of the Standard & Poor’s 500 stock index drives home the point: The 12 bull markets since the 1930s have all been followed by bear markets, or downturns of 20% or more, S& P Dow Jones Indices says. The average bear decline is a sizable 40%. Then there’s the megabears, like the 2007 to 2009 rout that knocked the S& P 500 down 57%. The current bull, second- longest in history and one that has generated a fourth- best gain of 254%, will eventually head lower. The only question is when. James Stack, a market historian and president of moneymanagement firm InvesTech Research, says there are seven warning flags that can signal trouble ahead. The more flags present at one time, the more danger there is. The good news, he adds, is that bull markets don’t typically “end with a big bang.” Market tops are usually slower- moving events that play out over many weeks.
Here are Stack’s seven warning flags:
1. TOO MUCH EXUBERANCE
The more optimistic and confident the investing public is, the riskier the market becomes. “Bear markets bottom in doom and gloom,” Stack says. “Bull markets peak when optimism is highest.” So what are signs of “extreme optimism”?
Bullish headlines, such as the recent Barron’s cover story, “Next Stop: Dow 30,000.” Hot IPOs, such as Snap’s 44% jump in its debut last week. A dearth of scared investors, measured by a closely followed “fear gauge,” dubbed the VIX, which is hovering near an all- time low. Skyrocketing consumer confidence measures, such as the Conference Board’s February survey, which registered its highest reading in 15 years. The Dow Jones’ recent run of 12 record highs in a row. Rising stock valuations are another yellow flag, and currently the market is trading at close to 20 times earnings, well above the historical average and double where it traded in March 2009.
“We have exuberance now,” Stack says, noting this is the only yellow flag so far.
2. INTEREST RATE SHOCKS
The 8- year- old bull has been powered by zero interest rates for nearly a decade. But the Federal Reserve has hiked shortterm rates twice in the past 15 months to 0.75%. Fed Chair Janet Yellen warns three more hikes of a quarter percentage point apiece could come this year.
In the past, market uptrends have been derailed by the Fed hiking rates faster and more aggressively than expected. Higher rates slow the economy, which hurts profitability of U. S. companies, a key propellant of stock prices. Higher rates also make it harder for borrowers to keep up with their debt payments, which could dent consumer spending and undermine the health of businesses with high debt loads.
3. HIGHER RISK OF RECESSION
“Bear markets and recessions go hand in hand,” Stack says. Seven of the past eight bull markets were undone by economic contractions, RBC Capital Markets data show. Recessions cause job losses, crimp consumer spending and squeeze corporate profits. Signs of trouble include weakerthan- expected incoming economic data, especially the Conference Board’s Leading Economic Index, which consists of 10 data points that predict future economic performance. If quarterly GDP, or economic growth, starts to slow, that’s another yellow flag, Stack warns. Any signs the manufacturing or services segments of the economy are turning down is also a bad sign. The latest reading on fourth- quarter 2016 GDP, however, was 1.9%, down from 3.5% in the third quarter, but far from the recessionary danger zone. Firstquarter 2017 economic growth is estimated at 1.9%, Barclays says.
4. FALLING CONSUMER CONFIDENCE
American shoppers account for roughly two- thirds of U. S. economic activity. So any signs consumers are not spending as much is cause for alarm. In February, the Conference Board’s closely followed consumer confidence index hit 114.8, its highest level since July 2001. That’s a far better reading than when it plunged below 30 in 2008.
5. TOP STOCKS WEAKEN
When market leaders, or bellwether stocks that are sensitive to changes in the economy, start to turn down after profitable advances, that’s an early sign investors are losing confidence, Stack says. Stocks to watch: ones that do best when times are good, such as banks, transportation companies and businesses that sell stuff to consumers that isn’t needed for daily survival.
6. FEWER STOCKS CARRY THEIR WEIGHT
A rising market driven by fewer and fewer stocks is a bearish sign. Clues include more stocks going down than up on a daily basis and more stocks hitting 52- week lows than highs.
7. BEAR- LIKE MARKET ACTION
When the number of stocks hitting their lowest price levels in a year starts to swell, and if the new low list grows day after day, it’s a sign the “smart money,” or professional investors, are bailing out of the market. “It means investors are becoming desperate to sell, even ... at a loss,” Stack says.
For now, most of these warning flags are not flashing yellow, Stack says. But the fact the bull market has lasted so long makes him “nervous and more watchful.”