5 Signals To Tell When The Bull Market Is Over

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The stock market always shows its hand before a significant change in trend.  History reveals there are a variety of signals that flash before stocks start to plunge.  After doing some digging, I’ve found five signs that the bull market may be about to end.

Here Are My 5 Favorite Signals The Bull Market Is Over

1. Extreme Optimism
Bull market tops are always characterized by excessive optimism.  Everyone from golf caddies to Uber drivers are excitedly talking about the stock market.  Tales of fortunes being made are abounding in the workplace as the public plunges into stocks with wild abandon.

Even Hollywood gets into the bullish mood with TV shows and movies focused on finance.  A prime example of this was the original “Wall Street” starring Michael Douglas.  While released in December 1987, two months after the great crash, the movie went into production during the monster bullish mid-1980s, thus forecasting the crash.

Today, accessible finance-related shows like “Shark Tank,” and the many real estate investing/flipping TV programs are signaling keen public interest in real estate and private equity.  Fortunately, for stocks, these shows are not directly about the stock market!  

Truthfully, I am not witnessing the public excitement surrounding equities like in 1987, before the tech/internet debacle, and the financial crisis of 2007. In fact, today, folks appear subdued and almost complacent about stocks despite the surging prices. It is indeed a strange phenomenon.

However, all financial markets are interconnected, meaning the public’s hype about private equity and real estate could be signaling the top in the economy, therefore, the stock market.

2. Ultra-High Valuations
Interestingly, ultra-high valuations may or may not be a signal for the end of the bull market.  However, every market top has been superseded by high valuations in stocks.  Metrics like price-to-book, P/E, price to dividends et al. are all signaling the market is trading at nearly historical high valuations in 2017.

Looking at the market top of 2007, stocks were more overvalued than they had been in over a century, with one notable exception.  The dot-com bubble of 2000 witnessed even higher valuations.

According to Yale professor Robert Shiller’s valuation metric known as “Shiller’s P/E,” stocks are hugely overvalued currently.  Shiller’s P/E is reading 31, which has only been seen before the crash of 1929 and before the dot-com bubble bust.

The Shiller P/E uses a longer time frame than the traditional P/E measure. It uses the past 10 years, rather than annually.  The reason for this is too smooth out distortions in the data, such as short-term price surges and dips.

Remember, however, that stocks can stay overvalued for inordinate amounts of time. On the other hand, no crash has ever started without stocks being extremely overvalued.

3. Trouble In Financials
The financial sector often leads the overall stock market.  Drilling down into recent history, regional banks appear to be even better signals of a top than the whole financial sector.  According to Hayes Martin, an investment consultant, July 2007 witnessed regional banks underperforming the total market, signaling the coming trouble.

While the overall financial sector is thriving right now, regional banks are telling a different story.  The S&P Regional Banks Select Industry Index is up by less than 2%, vastly underperforming the S&P 500 by nearly 11 percentage points.

However, going out over the last 52 weeks, the regional bank index posted 30% plus returns, compared with around 18% for the broad market.

I interpret this signal, despite the disconnect, as still being bullish for the market.  With the overall financials being the third strongest sector in the S&P 500, the recent regional bank slowdown may be a short-term blip.

4. Divergences
In plain English, a divergence occurs in the stock market when the majority of stocks are moving in one direction, and the indexes are moving in another.  Also, it can infer that the indexes are not running together.  Dow Theory teaches the Transportation Index must move in the same direction as the DJIA to support the bullish move.

Divergences are measured by the advance/decline line.  This technical tool compares the number of rising stocks to the number of falling ones. If most shares are falling, yet the indexes are climbing higher, it signals the bull run is about to end.

I took a look at the NYSE & Nasdaq advance/decline lines. The NYSE advance/decline line is near all-time highs, sending a bullish signal.  However, the Nasdaq line is down from its earlier peak.

We have not experienced enough, if any, divergence to signal a market top, yet.

5. The VIX
The volatility index or VIX is a measure of volatility in the stock market.  Climbing VIX levels indicate that institutional investors are fearing a correction, and are therefore purchasing portfolio insurance via derivatives. A falling or steady VIX level indicates bullishness or complacency in the equity markets.

While the VIX has recently slipped higher from near multi-year lows, it remains below its 200 week simple moving average of 14.55.

Big money appears to be very secure in the bull market moving higher or at the very least avoiding a significant correction.

Risks To Consider: The 900-pound elephant in the room is the geo-political situation.  All the above analysis goes out the window should a market-shocking event occur somewhere. Always use stops and diversify across investments regardless of how bullish things appear.

Action To Take: Based on these five signals, the current bull market can easily extend well into 2018.  Keep a close eye on the above five factors when making stock market decisions.

Editor’s Note: A few months ago, a group of millionaires and billionaires gathered in a private conference room 26 miles from Mar-a-Lago to discuss their “Trump Era” investments. And believe it or not, a common theme was to invest in American businesses. Seven companies in particular stood out… Full story here.

David Goodboy does not personally hold positions in any securities mentioned in this article. StreetAuthority LLC does not hold positions in any securities mentioned in this article.