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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 began in 2009, is in a mature stage according to NDR’s Tim Hayes.
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“With the secular bull market maturing, we are watching for signs that it may be at risk,” he said.
With the S&P 500 in its 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.
In a note on Friday, NDR chief global investment strategist Tim Hayes said the secular bull rally is in its mature stage, so investors should watch for warning signs such as extreme sentiment.
“What will signal that this is ending? 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 a lack of risk aversion would leave investors exposed to a degree of sustained macroeconomic deterioration that has not yet been experienced since the uptrend began.”
Hayes is not predicting an imminent spike in the stock market, especially with falling interest rates historically acting 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 with the secular bull maturing, we are watching for signs that it may be at risk,” Hayes said.
The first warning sign of a short-term spike in the stock market is the worsening breadth between the underlying themes of the US stock market.
In other words, if only a handful of companies drive the stock market higher, it would be a bad sign since it was at a secular peak in 2000.
Investors don’t have to worry about that signal yet, as recent data shows an increase in market breadth.
Extreme valuations would be another warning sign to watch for, according to Hayes, who added that high valuations are priced in in a perfect macroeconomic environment, and if something goes wrong, those valuations can unravel quite quickly.
“Expensive valuations seem justified when earnings growth is occurring, but that also leaves the market vulnerable when earnings decline,” Hayes said.
Long-term spikes in the stock market also typically occur when earnings growth and economic growth reach extreme levels, since the flip side of that boom is usually a rapid slowdown in growth.
The secular stock market peaks of 1929, 1966 and 2000 coincided with a peak in S&P 500 earnings growth, “after which prices fell amid the growing realization that valuations were not justified,” Hayes said.
While valuations and earnings growth are currently at high levels, they could have more room to grow, according to the note.
“The current level of earnings growth has not yet reached its 1929 and 2000 peaks, but has already approached its 1966 levels,” Hayes said.
He added: “In the event of a slowdown in earnings growth, we would expect to see a slowdown in economic growth.”
Finally, Hayes said investors should keep an eye on bond and commodity yields as they will reflect a possible pick-up in inflation. And a spike in inflation, along with a rise in interest rates, would be an unwelcome warning sign for the current bullish rally in stocks.
“If that were to begin to change with a severe cyclical downturn, secular bearish warnings would strengthen and we would likely see reversals from the extremes in valuations, earnings growth and economic performance,” Hayes concluded.
Read the original article on Business Insider