5 Indicators That The Stock Market Rally Is Over

Includes: DIA, SPY
by: Derrik Lattig

As stocks continued to climb into early March, investors started to ponder the possibility that it would continue its record setting trend. But during afternoon trading on Tuesday, the Dow had fallen 142 points from its all-time high, and has insinuated the question many investors are now asking, "Is it over?"

Anyone who says they know for certain where the stock market is heading is a prevaricator, but what we can do is look at historical trends, current market conditions, and make an educated decision on the direction it is most likely to take. With that said, I have made a list of the five things that could indicate that the recent stock market rally has seen the best of its days, and now may be on the down-slope of its March madness ride.

1. "The Dow will reach 20,000!"

In recent weeks, I have seen numerous financial analyst and economists predicting the Dow to reach inconceivable heights in the near future. JPMorgan Chief U.S. Equity Strategist, Thomas Lee, told CNBC that he believes the Dow could reach 20,000 in 4 years .How about Robert Zuccaro's infamous book titled, "DOW 30,000 by 2008!" Boy, was he ever wrong. These professionals have in some way or another tried to convince investors the precision and rationale behind their ludicrous predictions. It's not going to happen, and for those who remember, it brings back memories of "Irrational exuberance."

Former Fed Chairman Alan Greenspan coined the phrase in a speech in December 1996, just a week after a sustained Dow winning streak ended that year. Even bond guru Bill Gross, who refers to Greenspan as a friend, wrote in his March investment outlook that irrational prices are on the rise. The market will not increase forever, and if these "experts" keep reiterating that it will, it could do exactly the opposite of what their intentions were - driving it further.

2. The Job Market Is Still Bad

Don't get me wrong, the job market is better comparatively, but still has a long way to go before it reaches the Fed's goal of 6.5%. The 7.7% unemployment rate is a four-year low and has people excited about a recovery, but the recovery is still painful. Some even say the "improvement" in the job market is a hoax. The drop in the unemployment rate is coming mainly from people leaving the work force in record numbers - 1.2 million, mostly young folks who we need to support the housing market. Those who are finding work are finding part-time, low-wage positions. No wonder "hard" economic data such as a drop in retail sales and a rise in the savings rate suggest a lack of progress out there. In fact, during February, the number of full-time workers fell by 1.1 million. Not exactly a sign of strength.

The chart above says it all. It shows the number of people working full time as a percentage of the overall population. The government's seasonal adjustment has been removed.

As Dean Baker of The Guardian points out, a strong winter prefaced a dismal spring for job creation in the past few years. So let's not set off fireworks for employment growth just yet.

3. Stocks Are Not Cheap

Despite what you've heard about stocks being cheap compared to 2007, they're not. The price-to-earnings ratio of the Standard & Poor's 500-stock index is almost 18, vs. a mean of 15.5 and a median of 14.5 for the market historically. Valuation is a crucial part of the discussion, which has drawn attention to one gauge that measures how heated the stock market is - the CAPE ratio (also known as Shiller P/E and P/E10). The tool was popularized by Yale University economist and professor Robert Shiller, author of the book Irrational Exuberance, published just about the time the dot-com bubble burst in 2000. For brevity, Shiller P/E uses inflation-adjusted earnings across 10 years to determine valuation and avoid short-term noise affecting the data. And right now, that P/E is around 23, vs. a historical average of about 16. The numbers indicate that stocks are not only very expensive right now, but extremely overbought.

4. GDP Growth Is Dismal

As I mentioned in my recent article "Dow Reaches New Heights- Is the end near?" GDP growth over the last 5 years has been increasing, but at a historically low rate. Real GDP, which takes into account the effect of inflation, is about 2.9 percent higher than it was in October 2007. On an annualized basis, that's a dreadful growth rate of 0.58 percent. Most Wall Street experts aren't predicting much improvement for this year. How can the market continue to rally with such poor numbers? We experienced a similar situation in 2011 after a big surge through spring, which ultimately led to the market ending flat on the year.

Source: Bureau of Economic Analysis (BEA)

5. The Dreaded "Wedge"

The technical analysis mob is talking a lot about the current "rising wedge" pattern in the S&P 500 - an extremely bearish chart that typically precedes a breakdown. A rising wedge is a bearish pattern that signals that the security is likely to head in a downward direction and is characterized by an uptrend in prices where buyers eventually lose momentum. Both the long-term and the short-term trends indicate the bearish wedge pattern, and the lack of volume lately may be inferring that these prices are not maintainable.


So the question remains: when will the bear take over? All though my analysis is purely speculation, the aforementioned indicators are all signs that we should consider in the succeeding months of the recent record-setting bull market. The stock market rally has been a cash cow for anybody vested before the uptrend, but as we all know, every bull has its bear. The market will not increase forever, and a correction is inescapable, but just when that correction will be is anyone's best guess.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.