Yet Another Indicator is Flashing a Warning Sign

Over the past few months I have brought a number of different market and economic indicators that are hitting levels not seen in decades. The 10-year bullish run in stocks is a historic one and it has investors wondering how much longer it can last.

There was another indicator released last week that suggests investors should be cautious. The indicator is the Goldman Sachs Bull/Bear Market Risk Indicator and it is at its highest level since 1969.

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The indicator combines the average ranking of five different economic indicators to come up with one composite number. The economic indicators included are the ISM report, the slope of the yield curve, core inflation, the unemployment rate, and the Shiller P/E ratio.

Historically, any readings above 70% have been good predictors of bearish periods in the market. The most recent reading is up at the 75% level and that is concerning.

As you can see, the indicator peaked between the 70% and 75% levels in 2000 and 2007, just before the two most recent bear markets. Looking back farther, we see the indicator above the 70% level again in the 1972-1973 timeframe, just ahead of that bear market. The highest reading ever came in the 1967-68 timeframe and there was a bear market from November ’68 through June ’70.

While I found the report somewhat alarming, officials at Goldman Sachs seemed to backpedal a little from what their own indicator was suggesting. The report suggested that investors shouldn’t panic, but “a period of lower returns should be anticipated”.

In an interview with MarketWatch, Goldman’s Peter Oppenheimer stated, “We’re not flying the flag here and saying that there is going to be a deep bear market.” Oppenheimer is the company’s chief global equities strategist.

While I agree that investors shouldn’t panic, I don’t believe a period of lower returns is all we are in for. I think we will see a bear market and it will likely start in the next six to 12 months.

The Goldman indicator isn’t the only one that is alarming either. I have pointed out the extremely high level of consumer confidence, the rising rate of the 10-year treasury, and the high levels of optimism displayed in various sentiment indicators.

One of those sentiment indicators is the Investors Intelligence Bull/Bear ratio. I wrote about it back in January when the ratio was above 5.0 for the first time since 1987 and that was just before the correction in February. The ratio has been climbing again and is at 3.31.

What is really concerning is that if you look to the far left of the chart, you see a similar pattern in 1987—just before the crash. The ratio was up near 5.0 and then fell sharply, but jumped back above the 3.0 level just ahead of the October crash.

There are so many indicators flashing warning signs, it is unbelievable. But the market itself hasn’t shown any signs of trouble yet. Stocks continue to climb despite the various indicators and despite the black cloud of the trade disputes.

I agree with Goldman that investors shouldn’t panic, but I would suggest that investors take action to protect some of the gains they have. I would suggest lowering the equity portion of your portfolio by 10-15% at this point. If we start seeing signs from the market itself that a bear market is starting, you can then lower the equity allocation even more. For instance, if the 13-week moving average on the S&P 500 drops below its 52-week moving average, that would be a sign that the market could be entering a bearish phase.

Taking steps to protect one’s portfolio doesn’t have to be a one-step process. It can be a three or four step process where you lower your stock allocation in stages based on certain developments. The two worst things you can do are panic and sell everything all at once or do nothing and watch your gains get ripped away.

About Rick Pendergraft

Rick has been studying, trading, analyzing and writing about the investment markets for over 30 years. He has worked for some of the largest financial publishers in the world and he has been quoted in the Wall Street Journal, USA Today, the New York Times and the Washington Post. In addition, he has been interviewed on Bloomberg, CNBC and Fox Business News. Rick’s analysis process includes fundamental, sentiment and technical analysis. Rick started college as an education major, wanting to teach economics, but eventually changed to majoring in Economics and received a Bachelor of Science in Economics from Wright State University. His desire to inform and educate people is at the heart of his writing.