Rule Of 20 Signals Stocks Are Expensive

Let’s review the bear market signposts individually to see if they imply a bear market is coming. 11 of the 19 warning signs have been triggered. In previous articles, I’ve reviewed the first 14 of them and determined that 4 are unreasonable, meaning less worry should be given about an oncoming bear market. The 15th signpost is the yield curve inversion which we’ve discussed many times. This is the best indicator of an oncoming recession. It doesn’t catch every market peak, but it has a hit rate of 88% since 1962, with 1970 being the only time there was a bear market without an inversion within 24 months. The great part about this indicator is it doesn’t have false positives, like many of the others listed below. The latest difference between the 10 year bond yield and the 2 year bond yield is 52.5 basis points. It has inched closer to an inversion since this list was published. My target for an inversion is between the 2nd half of 2018 and the 1st half of 2019.

The 16th bear market signpost is the change in long term growth expectations. It’s triggered when the expectations increase by more than 0.6%. Since they have risen by 1.9%, this signpost has been triggered. Since 1986, this signpost has a 100% hit rate. Aggregate earnings growth estimates tend to rise within the last 18 months of bull markets. To be fair to this bull market, analysts have increased estimates, albeit by not enough to trigger the sell side signpost, because of the recent tax cut. It’s tough to say if this indicator means a bear market is coming because aggregate estimates are overzealous or that they are just accurately portraying the effect of the tax cuts. With a lower tax rate for the long term, margins will increase. The countertrend to this is potentially increasing financing costs. The tax cuts are near certainty while the changes in interest rates aren’t. This would cause the net effect on long term earnings expectations to be positive.