- Stocks are historically extended by many measures.
- This has led to a chorus of investors calling for a crash.
- We’ve compiled 9 indicators that show the breadth of extremity in market conditions.
- See more stories on Insider’s business page.
Investors seem to be walking on egg shells these days.
After a historic recovery from the fastest bear market in history – the S&P 500 is up more than 90% since the March 2020 lows – the tone on Wall Street appears to have suddenly shifted from unabashedly bullish to exceedingly cautious.
This has been accentuated by notoriously bearish investors – perhaps most notably Michael Burry, whose bet against the housing market ahead of the Global Financial Crisis was portrayed in the film “The Big Short” – calling for a crash in stocks ahead.
Threats to stocks abound. The market dropped about 1% on Thursday due to fears of the Delta variant of COVID-19 currently spreading in areas of the US. Inflation has risen more than expected in each of the last two months, and could very well do so again when June’s consumer price index is released on July 13. This could send bond yields soaring, potentially triggering an exit from stocks. And the Federal Reserve could taper asset purchases earlier than expected.
But it’s precisely because of their extraordinary recovery that stocks now sit in such a precarious position, vulnerable to a slew threats with their valuations inflated.
So, are stocks really due for a crash? It’s impossible to know for certain. But some indicators don’t paint a pretty picture.
While indicators are not the entire story and the market is a complicated beast, we’ve compiled below a list of measures them that show just how extreme some conditions in the market are at the moment – and that signal stocks could be due to take a break from their steady advance.
The Schiller price-to-earnings ratio for the S&P 500 is one of the most popular ways to measure the valuation of the broader market. It’s currently near all-time highs, near the level it reached during the height of the dot-com bubble. High valuations usually mean relatively muted future returns.
2. The Warren Buffett Indicator
Total stock market capitalization compared to GDP, commonly known as the Warren Buffett Indicator, is also at all-time highs. Buffett, a legendary investor, likes this indicator because it gives investors an idea of how much stock performance is tied to real economic growth at any given time.
3. Irrational Exuberance Indicator
Beyond valuation-based indicators, there are a number of measures of investor sentiment that show extreme bullishness. One is the Irrational Exuberance indicator from Bespoke Investment Group. It currently shows that investors are worried about valuations, but still think stocks will be higher in a year. It’s at historically high levels.
Lance Roberts, the chief strategist at Real Investment Advice, highlighted the indicator in a recent post.
“In simplistic terms, investors are as bullish as they can get,” Roberts wrote in the post.
4. Sentiment Cycle
Roberts also highlighted the Sentiment Trader Sentiment Cycle, and pointed out that all of the criteria for being in the “enthusiasm” section are currently being met. This could mean that investors enter “panic” mode soon.
5. CBOE Skew Index
Roberts also pointed to the CBOE Skew Index, which measures how much investors perceive risk or are worried about risk. It’s currently at an all-time high, meaning investors are very worried about a potential unforeseen catalyst derailing the market.
6. Median Price To Revenue Ratio Per S&P 500 Decile
Hedge fund manger John Hussman has been highlighting in his commentaries that the median price-to-sales ratio, another measure of valuation, for each decile of the S&P 500 is at all-time highs. This suggest the entire market is steeply valued, and not just a small area of it.
The Chicago Board Options Exchange Volatility Index, or the VIX, which measures expected volatility in the stock market and tends to move in the opposite direction of the S&P 500, could be set to spike. This is according to technical analysis from Morgan Creek Capital hedge fund manger Mark Yusko.
Sven Henrich, the founder of NorthmanTrader, has said also said in recent weeks that he expects a spike in volatility ahead.
8. Insider Selling
Yusko also pointed out that insider selling is increasing.
“Insiders know more about companies than investors. Insiders don’t sell at bottoms,” he said in a recent video. “Insider selling is the highest it’s ever been. There’s a reason for that.”
9. Sell Side Indicator – Bank of America
The July 1 edition Bank of America‘s Sell Side Indicator, which measures strategists’ stock allocation recommendations, showed that investor sentiment is hovering just around “extreme bullishness” territory, represented by the red line.
It’s currently as close to the red line as it’s been since the Global Financial Crisis.