Markets

5 Ways To Spot The Market's Top

Can the stock market go any higher?

This is the number-one question I've been hearing from investors recently. The Dow Jones Industrial Average, considered by many to be the most important market barometer, is higher by roughly 20% over the last year. An all-time high of 22,179 posted just a few weeks ago triggered massive bullish fever.

The question is, will 22,179 continue to mark the all-time high for the next several years or will the bulls continue to push stocks into the stratosphere?

The evidence is saying that the bulls are wrong and 22,179 will be the historical high for the DJIA through the end of 2018. To be clear, the DJIA will go higher in the future. In fact, it will go much higher over the next decade. However, for now, the top has posted.

Remember, the S&P 500 is higher by over 250% since the 2009 bottom. We are in the midst of an almost 100-month advance across the major stock market indexes, and valuations are pushing traditional limits.

My prediction is based on a combination of five factors that mark the top of the market. Any one of these signs is a bearish signal, but the combination of all five makes a strong case that the market is done surging for now.

Five Signs The Top Is Here

1. The Federal Reserve

The central bank did a tremendous job navigating the economy through the Great Recession. Their actions triggered the monster bull market that is happening right now. But now, the bank has begun to normalize interest rates.

However, several dangers with the Fed's planning will cement the market top. First, should economic growth accelerate, it may push the Fed towards drastic action, leading to a more dramatic spike in interest rates. Whenever growth gets out of control, the Fed has a history of over-reacting, which tanks the stock market.

Second, controlling inflation is a huge impetus for the Fed to ramp things up. Should the Fed discover it is underestimating inflation growth, it could be forced to shock the system with surprise rate hikes.

Third, if the Fed-triggered drop combines with a recessionary environment, it can spell an extreme market meltdown. The tech bubble blow-up, the Great Recession, and even the painful bear market of 1973-1974 all were greatly exacerbated by the interest rate environments surrounding them.

Lastly, the wind down of quantitative easing measures is an unknown factor. There is a limited precedent as to how shrinking global central banks' balance sheets will affect the financial markets. There could be some bearish surprises in store.

2. Ultra- High Valuations

The S&P 500 is trading at nearly 18 times one-year forward estimated earnings. It has not been this high since the dot-com bubble.

High valuations in and of themselves are not signals for a market top. Investors often irrationally point toward historically high valuations as a reason to turn bearish.

At the same time, bear markets rarely occur in an environment of low valuations. High valuations are not a trigger for the sell-off, but they are another factor that could lead to the market top.

3. China

I am a long-term bull on the Chinese markets. However, there remains a distinct possibility of China's burgeoning capitalistic economy imploding during its upward growth path. Should China suffer extreme economic stress, it will result in bearish shockwaves through our interconnected stock markets.

4. Government Anti-Trust Actions

While this is speculative, I have observed a distinct uptick in government anti-trust actions. Starting under the Reagan administration, a pattern of increased regulations has worked to prevent maximum economic growth. In 2016, the FTC and DOJ have stymied and challenged a higher percentage of business-positive deals than ever before. It remains to be seen if the Trump administration's rhetoric will be put into action to stop this stock-killing trend. However, signs are showing that it will not, which leads us to the fifth factor.

5. Donald Trump

Trump roared onto the political scene with a massively business-positive message and stocks reacted by shooting to all-time highs. However, the difficulty of implementing these changes was not considered by the bulls. Now, Trump fatigue is setting in with even his most ardent supporters. Should this disillusion continue to climb, it could easily trigger an extreme bearish backlash and the stock market will react sharply.

Risks To Consider: No one knows for certain what the future holds. All we can do is read the signs and attempt to protect our portfolio to the best of our ability. Remember, the stock market can remain irrational longer than investors can remain solvent.

Action To Take: Keep a close eye on the above bearish factors. Consider taking profits and going to cash with a portion of your portfolio.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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