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Ned Davis Research says investors should watch for signs of a possible spike in the S&P 500.
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The secular bull market, which started in 2009, is in a mature stage, according to NDR’s Tim Hayes.
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“Now that the secular bull is mature, we are watching for signs that it may be in danger,” he said.
As the S&P 500 enters the 15th year of a secular bull market that began in 2009, Ned Davis Research says investors should watch for warning signs of a potential spike.
Tim Hayes, NDR’s chief global investment strategist, said in a note Friday that the secular bull rally is in a mature stage, so investors should be alert to warning signs such as sentiment extremes.
“What will warn that it is coming to an end? The answer comes down to sentiment: so much positive news for so long that it has become the new normal,” Hayes said.
He added: “The risk is that the lack of risk aversion exposes investors to a degree of sustained macroeconomic deterioration not yet experienced since the bull wave took off.”
Hayes isn’t calling for an impending stock market peak, especially since falling interest rates have historically acted as a tailwind for stock prices, but he is aware that it could happen.
“The last two secular bulls lasted 24 years (1942 – 1966) and 18 years (1982 – 2000). But now that the secular bull has matured, we are watching for signs that it may be in danger,” Hayes said.
The first warning sign of a short-term stock market spike is the worsening of the underlying problems in the US stock market.
In other words, if just a handful of companies are driving the stock market higher, that would be a bad sign, just as it was at the secular top in 2000.
Investors don’t have to worry about this signal going off yet, as recent data points to an increase in market breadth.
Extreme valuations would be another warning sign to pay attention to, according to Hayes. He added that high valuations in a perfect macro environment could yield a price. If something goes wrong, those valuations can fall apart quite quickly.
“Expensive valuations appear justified if earnings growth continues, but that also makes the market vulnerable if earnings fall,” Hayes said.
Long-term stock market booms also typically occur when earnings growth and economic growth reach extreme levels, as the other side of that boom is usually a rapid slowdown in growth.
The secular stock market peaks of 1929, 1966 and 2000 all coincided with a spike in S&P 500 earnings growth, “after which prices fell due to the growing realization that valuations were not justified,” Hayes said.
Although valuations and earnings growth are currently at high levels, there could be more room to grow, according to the note.
“Current levels of earnings growth have yet to reach the levels of the 1929 and 2000 peaks, but are already closer to 1966 levels,” Hayes said.
He added: “With a decline in earnings growth, we expect a decline in economic growth.”
Finally, Hayes said investors should keep an eye on bond yields and commodities as they will reflect a possible recovery in inflation. And a rebound in inflation, coupled with rising interest rates, would be an unwelcome warning sign for the current bull rally in stocks.
“If that were to change with a severe cyclical bear, secular bear warnings would become stronger, and we would likely see reversals from extremes in valuations, earnings growth and economic performance,” Hayes concluded.
Read the original article on Business Insider
