Thursday, April 4, 2013

3 Indicators that the Bull Market will not run much higher

This article about market conditions by John Hussman presents a couple strong indicators that the stock market is currently overvalued.

1) Currently, few investment advisors are bearish.  The percentage of investment advisors with bearish sentiment is now 18.8% of all advisors.  Historically, bearish advisor sentiment below 20% has portended significant market declines.  You read that right.  This is a contrarian indicator: when advisors are less bearish the market has declined.  This link explains the indicator:

2) Stocks are expensive compared to earnings.  The Shiller P/E is currently above 23X.  The Shiller P/E (Price to Earnings) is the total value of the S&P 500 divided by the 10-year average of inflation-adjusted earnings.  Historically, a Shiller P/E above 18X has indicated overvalued markets.

A chart of the Shiller P/E over time is here:

The S&P P/E today based on trailing 12 months of earnings is 18X.  The historical median for this measure of P/E is 14.5X.

3) Corporate profits after tax are 11% of GDP.  Historically, corporate profits average about 6% of GDP.  And, according to the Fed Reserve Bank of St Louis have never been above 10.5% until recently.

This all make sense.  The S&P is up 10% year to date and all the analysts are jumping on board.  Stocks are expensive to earnings because investors are bidding up alternatives to paltry interest rates on bonds with easy money from the Fed.  Corporate profits are a larger portion of the GDP 'pie' because the government and household sectors are being squeezed.  So, the question is when.  When will markets and valuations revert to the mean?  When will extend and pretend end?  My guess is within 3 years from now.  And, it seems that the current bull market in equities has little room to run higher.

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