There are a lot of articles discussing data points which can help investors predict markets. Most have some value in them (though not all). In this vein, the Wall Street Journal has done some digging to assemble the eight best historical market signals. The first thing to know is that all eight predictors, each of which has a great track record, show that market returns over the next decade will be below average. Even the most bullish of the group says that returns will be way below what they have been over the last decade. Some of the eight predictors include the Household Equity Allocation, the Q Ratio, the Buffett Indicator, the CAPE, and the Dividend Yield. The Household Equity Allocation has historically been the most accurate, as households tend to have the highest allocation to stocks right before a crash.
FINSUM: That is quite a data set stacking up against the market. We expect a rough market and a recession within 18 months, but the gains until then could be good.
It is not pleasant to think about, but investors may need to face reality—the bear market may have arrived this winter. Stocks are already well into a correction and the immediate path forward doesn’t seem bright. All that said, not all the indicators are showing a bear market to come. Bank of America has assembled 19 indicators which have forecasted bear markets in the past. Right now, only 13 of the 19 indicators have been tripped, meaning the market may have room to move higher. While 13 out of 19 may sound high, this level was usually reached two years before the peak in prices in previous bear markets.
FINSUM: If you buy into these types of indicators, the big x-factor is how quickly the other 6 could be tripped. The big problem, of course, is that the returns at the end of a bull market tend to be the strongest, so one does not want to take all their chips off the table.
The whole market is worried about a share collapse. Markets have been rising inexorably, and there seems to be fear that a sense of euphoria prevails amongst investors. The market appears to be overbought on the back of positive sentiment. While the prevailing wisdom is that overbought and euphoric markets tend to perform very poorly, the fact is, an overbought market in itself is not a reason to sell. The market can often keep rising for some time, and produce significant gains before it finally reverses, such as the Nasdaq in 1999-2000.
FINSUM: The market looks very vulnerable at the moment, but that does not mean it won’t keep rising. Investors need to be willing to miss out on gains if they intend to cash out now.
Many investors and pundits are worried the bull market is on its last legs. Beset by high valuation, many think stocks are due for a major correction or bear market. However, one of the most respected stock gurus in the industry, Byron Wien, thinks the opposite, saying this bull market has two years or more to run. The main reason for the argument is that the signs that usually portend a bear market simply aren’t there. There is no inverted yield curve (it is actually steepening), and sentiment on stocks is definitely not euphoric. Even hedge funds look cautious; another sign that stocks are not at the stage of collapse. With all this in mind, Wien thinks stocks look good at least until 2019.
FINSUM: While we agree that stocks valuations are worrying, we too feel that the market is not at the overly optimistic state where things begin to unravel. Shares may yet climb this wall of worry.
The market has done well this year, and while many are worried about rising valuations, investors keep piling into the stock market. However, that may be exactly the reason that stocks could be poised to fall. The indicator to watch is the ratio of average allocation to equities. Interestingly, when this number is high, stocks tend to perform very poorly in subsequent years, while when it is low, they do well. Right now the average US allocation to stocks is 39.2% of financial assets, a level which was hit only one other time since 1950 (in the late 1990s). The other times it has hit high levels, bear markets or bad returns have followed. The catch of the figure is that it does not mean any drop is imminent, it is better used for long-term forecasting.
FINSUM: This is a classic contrarian indicator, and definitely something to pay attention to.