How and When Bull Markets End – Signs Investors Should Watch and Where We Are Today

Written by Eleftherias Courtalis

Bull markets sometimes end with a bang, and other times in tears, notes Bank of America. The S&P 500 continues to break previous highs, the VIX fear index is declining and credit spreads are narrowing, reminding us of the calm before the storm. He points out that high valuations and tight monetary policy have worried investors, adding that in recent weeks he has received many requests from investors about the signals that bull markets send and the signals that typically precede the peak of the S&P 500.

So he decided to answer these questions and provide some of the strongest signals. The good news; Today 40% of signals indicating a market peak are activated, compared to an average of 70% before previous market tops.

What happens before the S&P 500 peaks?

Investors cite “rules” covering valuation, technical analysis, geopolitics, macroeconomics, and behavioral finance as indicators of market peaks and troughs. Bank of America analyzes indicators that typically precede a peak and concludes that “false alarms” based on these indicators are historically limited. There is no… Holy Grail, but the confluence of these signals could highlight the increasing risk of a market decline and thus the end of the bull market.

What should we pay attention to?

Thus, Bank of America highlights indicators that typically preceded market peaks and had fewer false positives during bull markets. These relate to bullish investor sentiment/sentiment (stock positions, high consensus analyst growth forecasts), late-cycle mobility (increasing M&A activity, rising consumer confidence, rising investor sentiment), valuation (increasing P/E + inflation), and macroeconomic tightening ( inverted yield curve) and tightening lending (credit markets). But most peaks also have unpredictable triggers that are then resolved in the next cycle.

especially:

Consumer confidence: Bank of America reported that in terms of consumer confidence, the Conference Board’s Consumer Confidence Index typically reaches 110 points six months before the market peak. This index touched 111 points in January 2024.

Bullish sentiment: The upside (extremely positive sentiment) in the market exceeded 20% six months before the hidden market. Today, 48% of investors expect prices to rise in the next 12 months versus 25% who expect a decline, so the upside is forming at 23%, according to Bank of America calculations.

Positions in stocks: The Sell-Side Index (SSI) tracks the average recommended allocation to stocks by Wall Street strategists. It has been a bullish signal when Wall Street is very bearish and vice versa. In three of the last six markets, the sell-side indicator issued a “sell” signal within six months of the market peak (and it was very close before the 2022 bear market). The SSI is in the ‘neutral’ zone today, about halfway between a ‘buy’ and ‘sell’ signal, so it is not ‘triggered’.

Analysts’ expectations for growth: As with the SSI, analysts’ long-term growth (LTG) forecasts for S&P 500 companies tend to be inversely related to lagged market returns. When expectations are high, stocks are more likely to disappoint, and vice versa. At four of the previous six market tops, the S&P 500 LTG forecast was greater than 1. Expectations have been rising for more than a year, but they are still low (just 0.2).

merger and acquisition: An increase in deals can indicate confidence and a late extension of the cycle of growth opportunities. The number of M&A deals rose steadily ahead of the tech bubble, global financial crisis, and 2022 bear market. Within six months of this market peak, the number of M&A deals (3 million deals combined) exceeded the 10-year average. Merger and acquisition activity has increased over the past 12 months, but is well below the threshold.

Ratings: Valuations and inflation have been mostly inversely related, with higher inflation tending to reduce valuations mostly through the benefit of higher profits. The S&P 500 typically peaks when the sum of its P/E and CPI for the year is at least one standard deviation above its 10-year average. The current P/E and CPI of 3.3% per year (sum = 27) are 0.9 standard deviations above the mean, just below the stimulus threshold.

Performance curve: An inverted yield curve (long-term interest rates falling below short-term interest rates) indicates weak growth prospects. In five of the past eight bear markets, the yield curve inverted at some point during the past six months. The yield curve has inverted since July 2022, the longest continuous inversion on record.

Credit Terms: Banks usually start tightening lending standards before the market reaches its peak. With 16% of banks tightening credit since the first quarter, this indicator has been triggered.

What should we not worry about?

Bank of America points out that many indicators appear alarming but contain little information. A federal funds rate above neutral is considered restrictive, but has been so for decades, including throughout the bull markets of the 1970s, 1980s, and 1990s.

The VIX as an indicator is rather weak today: many spikes in volatility, i.e. the VIX, coincide with market lows, and mean reversions from lows require patience – the VIX has fallen twice as much as it has increased on a monthly basis.

Limited market depth, earnings revisions and initial unemployment claims are other signs that often precede market tops but have limited predictive power.

Is it better to sell early or late at market highs?

Bank of America did not respond to this. Staying invested is generally better than selling your market positions “emotionally”. sales.

History shows that with perfect foresight, selling one to three months early would have protected investors because the profits sacrificed were less than the losses over the following three months.

But over a period of 6 months, the effect is neutral, while it becomes positive if the person stays in the market for at least 12 months.

For the S&P 500 in particular, time is literally on investors’ side: the odds of losses decline sharply as time horizons expand.