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With the current bull market celebrating its fourth birthday by flirting with all-time highs, investors need to look hard for signs of where stocks are going from here.
Last week, the Dow Jones Industrial Average came within 20 points of its all-time record close of 14,164.53. Two weeks ago the Standard & Poor's 500 Index came within 31 points of its all-time high of 1,561.80.
Unfortunately, most market indicators are suggesting that the bull market that has carried U.S. stocks a long way from the lows of March 2009 is just about out of steam.
"There are a lot of measures that tell us markets are overbought at this point," Philip Saunders, head of multi-asset funds at Anglo-South African fund manager Investec, told the Financial Times. "Nothing goes up in a straight line."
That's not to say necessarily that we're facing a full-blown stock market crash, but that the likelihood of some sort of downturn has increased dramatically in recent months.
Many of the best indicators of a nearing change in the direction of stock markets are contrarian – that is, they appear to tell you the opposite of what you're currently observing.
But that's also what makes them valuable. No one wants to be the last person to leave the party, particularly when that party is a bull market.
Here are five indicators investors need to bear in mind:
Five Signs of a Weakening Bull Market
- 1. Low Volatility: One might think that low volatility is good for the average investor, but it simply isn't so. As Money Morning Chief Investment Strategist Keith Fitz-Gerald said recently, low volatility "tends to precede powerful reversals that can wipe out investors, as was the case in 2000 and early 2008, and at other key turning points over the past 100 years." Right now, the S&P volatility index, known as the VIX, is about 15, and has been in that low territory since mid-January. The normal range is between about 20 and 40.
- 2. Bull Market's End Overdue: The bull and bear cycles of the stock market tend to follow set patterns, and this bull market has already lasted longer than average. According to Birinyi data, the average duration of bull markets since 1962 has been four years – the exact length of the current one.
- 3. Short Selling Plummets: Short sales – bets that stocks will drop – fell to just 5.6% of shares trading last month. According to Bloomberg data, in the past two years stocks have declined soon after short selling fell to such low levels – 0.4% in March 2011 and 3.3% in March 2012. "When you have a market where investors are all in, there will no longer be short covering," Jeff Sica, president and chief investment officer at SICA Wealth Management, told Bloomberg. "As short interest has continued to decline, I see it as a sign of a market top."
- 4. Insider Selling Spiking: Recent insider trading has tilted strongly toward selling in recent months, a very bearish signal. According to data released by Argus Research last month, insider selling outpaced insider buying by a ratio of 9.2-to-1. When insiders are selling while everyone else seems to be buying, there's usually a very good reason.
- 5. Very Bullish Sentiment: Several indicators of investor sentiment have been unusually high lately, and that typically signals a market top. CitiBank recently reported that its Panic/Euphoria model had "spiked to near its highs of the past three years, suggesting frothy levels have ensued." The Financial Times reports that the similar BNP Paribas "Love-Panic" index is "now flashing warning signs in both the U.S. and Europe."
Finally, it's worth noting that a recently created index, which incorporates indicators such as the VIX, as well as eight other technical, macroeconomic and fundamental factors, is also flashing a warning that this bull market is in danger.
The "Greedometer" – created by Jeff Seymour of Triangle Wealth management – was designed based on previous market crashes. Feeding the old data into the Greedometer shows that it looked the same in 2000 and 2007 – years that preceded stock market crashes – as it does now.
On Feb. 22, the Greedometer reached 7,900 on a scale of 8,000.
"Stock markets die of euphoria," Seymour told MarketWatch. "These are the signals you look for."
Related Articles and News:
- Money Morning:
As Volatility Hits New Lows, It Could Be Time to Sell
- Money Morning:
Five Stock Market Charts Bears Have Been Waiting For
Danger as stock-market "Greedometer' flashes red
- Financial Times:
Equities: A sentimental wager
- Bloomberg News:
Short Sales Decline 53% as Bull Market Enters Fifth Year