Thursday, July 25, 2024

The raging bull market hasn’t peaked just yet, BofA says

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Stocks have surged to record highs this year on the back of an unexpectedly resilient U.S. economy and a euphoric AI boom. Defying Wall Street’s already buoyant—and still rising—forecasts, the S&P 500 has soared more than 15% year to date, while the tech-heavy Nasdaq has spiked roughly 20% as Big Tech continues to get bigger.

Analysts are scrambling to keep up with the market, with a top bear even turning bullish. But while this epic first-half market surge and increasingly lofty valuations have led some to fear a correction could be on the way, Bank of America doesn’t yet see enough of the 10 classic signs of a bull market peak.

“We have seen a surge in requests over recent weeks for bull market signposts, the triggers that typically precede an S&P 500 peak… The good news? Today 40% have been triggered versus an average of 70% ahead of prior bull market peaks,” Savita Subramanian, Bank of America’s head of U.S. equity and quantitative strategy, wrote in a Friday note. 

She noted that her 10 signposts—which include measures of consumer confidence, credit stress, earnings growth, and more—aren’t the “holy grail” for predicting stock market peaks. But when enough of them are triggered, it signals increased risk for investors. 

For now, though, with just four out of 10 signposts flashing warning signs, Subramanian recommended investors avoid panic selling. She also noted that many of the classic bull market peak indicators that other strategists use “sound worrisome but have little information content.”

The veteran strategist went on to caution that attempting to time market entries and exits in order to avoid short-term losses is typically a fools’ errand. “Remaining invested is generally superior to emotional selling,” she said. “For the S&P 500, time is literally on your side: the probability of loss in the index over a 1-day period is roughly equivalent to a coin flip, but drops precipitously as time horizons extend.”

Keeping those words of warning in mind, it may still pay to track Subramanian’s 10 bull market peak signposts, particularly for more active investors. Here’s what the strategy guru monitors when she’s looking for signs of a market correction.

The 10 signs of a bull market peak

1. Consumer confidence (Triggered)
Consumers’ mood tends to improve before bull stock market peaks. The Conference Board’s Consumer Confidence Survey typically hits 110 or higher within six months of a market peak, before falling alongside stock prices, according to Bank of America. This indicator was triggered in January, when it hit 111.

2. Consumers turning bullish on stocks (Triggered)
Despite U.S. stocks’ impressive history of gains, consumers’ forecasts for stock market returns are typically quite low. When that changes, it can signal a market peak. Historically, when the Conference Board’s survey shows the net percentage of consumer bullishness on stocks tops 20%, a market peak occurs within six months. This indicator was triggered in the spring; a net 23% of consumers are now bullish.

3. Sell-Side Indicator
Paradoxically, when Wall Street analysts are extremely bullish, that can be bad news for stocks. In half of the last six bear markets, BofA’s Sell-Side Indicator—which tracks analysts’ average recommended portfolio allocation to stocks—has flashed a “sell” signal within six months of the market’s peak. The indicator is currently in “neutral” territory.

4. Long-term growth expectations
When analysts’ long-term growth views for the S&P 500 are more than one standard deviation above the five-year average, it can signal a market peak is on the way. “When expectations are high, stocks are more likely to disappoint,” Subramanian noted.

5. Elevated mergers and acquisitions activity
When M&As rise one standard deviation above the 10-year average, it may signal confidence and a late-cycle stretch for growth opportunities, Subramanian explained. M&A activity soared prior to the 1990’s dot-com bubble, the Global Financial Crisis, and even 2022’s bear market. It’s rising again today, but still well below the threshold that would trigger Subramanian’s indicator. 

6. Valuations plus inflation
A high price-to-earnings (PE) ratio—a common metric used to value stocks—coupled with high inflation is a bad sign for markets.  When the sum of the S&P 500’s trailing PE ratio and the annual consumer inflation rate reaches one standard deviation above its 10 year-average sum, it has signaled a market peak 66% of the time since 1990. It’s currently 0.9 standard deviations above the average.

7. Performance of “expensive” vs. “cheap” stocks
Stocks with low PE ratios (cheap) tend to outperform those with higher PE ratios, but that changes before stock market peaks. Low PE stocks have underperformed high PE stocks by at least 2.5 percentage points in the six months before five of the last seven market peaks. Even with value stocks underperforming growth stocks this year, however, this indicator hasn’t been triggered.

8. The yield curve (Triggered)
When long-term U.S. Treasury yields drop below short-term U.S. Treasury yields, it can signal weakening economic growth expectations and even a market peak. This dynamic, called an inverted yield curve, has happened before five out of the last eight bear markets. The yield curve has been inverted since July 2022 in the longest inversion in history.

9. Credit Stress Indicator
Bank of America’s credit stress indicator measures credit access, leverage, distress loans, and more to determine the health of the consumer and forecast stock market peaks. It has dipped below 0.25 within six months of three of the last five bull market peaks, but currently sits at 0.39.

10. Credit conditions: Senior Loan Officer Opinion Survey (Triggered)
Banks tend to make loans more difficult to get prior to stock market peaks; this is known as tightening credit conditions. Bank of America looks at the Senior Loan Officer Opinion Survey to measure credit conditions, and with a net 16% of banks tightening commercial and industrial loans to large companies, the indicator is flashing a warning sign.

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