MOOSPEAK: JAN10.2025
LOOKING AT A MARKET TOP?
We’ve had two years of 25% gains in the S&P. Making money in US stocks looks like shooting fish in a barrel at this point. Of course, past performance is no guarantee of future success. Suddenly there is talk around the investment community that we might be looking at a US market top in the coming months if not sooner. Globally, in the latest quarter, equities in Europe (-8.5%), Asia-Pacific (-11.8%), and Latin America (-17.3%) all appear to have put in tops between August (ILF) and early October (IEV, AAXJ). At the very least they have corrected or are headed toward a 10% correction.
US and foreign stocks are highly correlated. Prices move together over the long term, but so far US small caps (-2.0%) and large caps (+0.2%) are holding up in the latest quarter, mostly due to the strong Dollar.
So how much veracity should we give to warnings of a US top? There are several signs that analysts look at, but they can last for years. Forget trying to time a top perfectly. The only rule of thumb is that a top can form after a minimum nine-month bull market. Apart from that a bull market can last a decade or longer. The last US bear cycle (down 20% or more) ended in October 2022, so this bull is going on 27 months. When we do finally put in a top hindsight will be 20-20. Meanwhile ask the following:
Is the market expensive? Is exuberance rampant? Is confidence high? Is speculation up? What are stock prices telling you?
An expensive market is one where both the trailing Price-Earnings ratio (currently 27.73) and the forward PE (currently 23.27) are both greater than the long-term average PE (15.83). That makes implied earnings growth in 2025 greater than 19%. Earnings growth was running at 8% in the first half of 2024 the latest period for which there is data. So on a longer term basis stocks could seem expensive. Short-term, however, our 14-day RSI overbought-oversold indicator @39 has SPY closer to oversold (30) than overbought (70).
An exuberant market can be identified using the VIX volatility index. Generally, when the VIX gets 20% greater than its ten-day average a serious decline has begun. Currently the VIX is only 12% above its 10-day average, bearish but not critically so. Longer term a 330-day regressed slope of the VIX shows that it was complacent (negative) in 2024 but getting less so until September 2024, when it turned positive. The slope peaked on election day and has been flat since.
Increased speculation is evident in the 104% post-election surge in Bitcoin from early September to mid-December. Before that the ongoing fascination with all things AI kept 7 tech giants at the top of the S&P for most of 2024. A more precise speculative indicator is margin expense, borrowing to buy stocks. When margin debt is greater than 55%, we are usually near the end of a bull market. Currently the number is just under 50%.
Increased confidence can be measured by a big increase in initial public offerings. A year later things can go south. The most IPOs in a single year (1035) in 2021 preceded the last bear market (2022). The lowest was 62 in 2008. Both numbers, however, were outliers (due to Covid and the Great Recession). The number of annual IPOs usually falls in the 100 to 400 range. Above 250 can mean problems the following year but not always. IPOs came in at 225 in 2024, a bit light for a top, (https://stockanalysis.com/ipos/statistics/)
Newsletter publishers are also a confidence indicator. Bull-Bear Spreads denotes the percentage difference between bullish and bearish perceptions by a set of respondents. Overly Bullish denotes a downturn coming. The US Investor Sentiment, % Bull-Bear Spread is currently -2.70%, i.e. leaning bearish. That’s compared to 1.27% last week and 25.07% last year, and lower than the long-term average of 6.75%.
Narrowing sector leadership is also a sign of waning confidence. Currently 67% of the sectors we track are better than cash vs 89% on election day. That is still a broad swath of the market (more than 50%) that’s neutral or bullish, but the erosion is definite.
Market internals that can help identify a top include a decline in the number of new 52-week highs. There were 474 new highs on election day (11/6/24) and only 36 this Friday 1/10/25. (Stockcharts: $NYHGH). A decline in the rate of advance of the NYSE can also foretell a top. When the AD Line breaks below its 200-day, (Stockcharts:!ADLINENYC) weakness is likely. It is there as of 1/10/25. Similarly beware when the High-low oscillator is negative and below its 200-day as it is now. (Stockcharts: $OEXHILO)
In addition, a CBOE equity Put-Call ratio reading below 0.50 is bullish; and above 0.70 is bearish. Currently the reading is .70 (Stockcharts:!PCRATEQU) but the 50-day SMA is .56 or in the neutral range. Finally, chart technicals can mark a turn. A lower low on a down day may signal the uptrend has failed and the top is in. This Friday (1/10/25) gave such a signal on both the SPY and IWM chart, as they each hit new 20-day stop-losses.
For any of this to signal a top and not be a head-fake, I sense we’d need a stronger triggering event than we’ve seen so far. Monetary missteps by a Fed known for them should hardly be a reason to sell-off. We’ll have a better idea of the trouble we’re in after next week’s inflation data. For now the models have gone to cash or gold and diversified portfolios (AOA and AOM) have hit stop-losses. I would wait until next week, however, before exiting SPY, and I might not exit diversified buy-and-hold at all.