Are We There Yet? What A Market Top Could Mean For Investors
The second longest bull run in history has continued to march forward this year with almost no indications of trouble. Even the single largest single-day drop of the year had little lasting effect, with the markets bouncing right back to positive territory the next day. The seemingly endless bull market has some investors nervous about when it will finally end.
The longest bull market on record lasted nearly 13 years from 1987 to 2000, so the current market still has quite a ways to go to match that since it began in early 2009. With the markets trading at all-time highs, it’s hard to say when the top has officially been reached, but there are some clues we can uncover to help predict how healthy the bull is right now.
Pricing Out the Top
One of the best ways to determine where the market is is to look at the average price-to-earnings multiple of an index like the S&P 500. The historic average P/E is around 15 times earnings – right now it stands at just shy of 25 times earnings. While that may be nearly 66 percent higher than the average, it doesn’t necessarily mean that a correction is immanent based on that information alone. From roughly 1997 to 2004, the average P/E was higher than the historic average, meaning that market stayed bullish at extremely high valuations for at least three years before a correction.
Another way to predict how close we are to a top is to look at volatility. This is done through the colloquially named “fear gauge,” or the VIX volatility index. Anything higher than 20 indicates heightened investor worries, but despite several temporary ticks above that level, the VIX has stayed more or less low for the past five years. Interestingly, many investors believe that continued low volatility means they aren’t pricing in market dangers correctly, so negative events build up over time until a correction becomes inevitable.
Finally, a tried and true method of predicting corrections has to do with the level of margin debt in the markets. As of March, NYSE margin debt levels stood at more than $536 billion – a record high. In 2010, margin debt levels averaged about $250 billion, meaning investors are now taking on more risk over time. The more leverage in the market, the greater the downside swing when a bear market finally reveals itself.
While a single anomaly can be explained away, having multiple indicators giving off red flags should cause concern for investors. A bear market might not happen tomorrow, but there seems to be enough evidence to suggest that stocks are overvalued with investors taking on more risk than usual and not pricing in market dangers correctly. The bull market could continue to plunge forward despite the risks, but investors would be cautioned to take some defensive precautions going forward. There’s a good chance that we’re already at a market top.