Is the bull market finally coming to an end? The S&P 500 (SNPINDEX: ^GSPC) has more than doubled over the past four years, and it’s up 11% year to date. However, it’s roughly flat over the past month. The current negative market sentiment is tied to worries about artificial intelligence (AI) spend and high oil prices.
Does that mean a crash is on the way? Not necessarily. But don’t be caught off guard if the bubble finally bursts. Here are three indications that a market crash could be happening soon.
Missed Nvidia in 2009? This Rare Signal Is Flashing Again. In 2009, a “Double Down” signal flashed for a little-known chipmaker called Nvidia. For the first time in years, that same “Total Conviction” signal is flashing for a company 1/100th the size of Nvidia. Continue »
1. Investors are “playing with fire”
In 1999, at the height of a bull market, Warren Buffett wrote an article for Fortune explaining why a market drop was likely. The S&P 500 peaked in March 2000, capping more than five years of double-digit returns before beginning to fall.
In December 2001, he penned another article explaining why the January 2000 market crash was inevitable. By that time, the S&P 500 had fallen 25%, and Buffett was confident it would fall further. In total, the index lost almost half of its total value from peak to trough, and the Nasdaq-100 lost 83%.
Buffett’s not a prophet; he just understands economics and markets. He explained that corporate earnings growth can’t substantially outpace gross domestic product (GDP) growth. As the sentiment of how companies are doing, measured by total stock market value, increases relative to GDP, stocks become overvalued.
His formula to gauge that metric is simple: Divide the total stock market value by GDP. If the result is 70% to 80%, Buffett says that “buying stocks is likely to work very well for you.” If it crosses 200%, like it did before the market crashed in 2000, he says, “You are playing with fire.”
Today, what’s now known as the Buffett indicator stands at 301%.
2. Prices are outpacing earnings
The CAPE ratio is another measure of how expensive the market is right now. It was developed by economist Robert Shiller and is also known as the Shiller CAPE ratio. It stands for cyclically adjusted P/E ratio, and it’s calculated by dividing the level of the index, here the S&P 500, by the average 10-year inflation-adjusted earnings.
The average CAPE ratio over time is 17.8, and it has surpassed 40 only twice: once before the dot-com crash in 2000, when it hit an all-time high of 44, and now.
