The three charts at the top of this post show the three main indicators I use to help me stick with the direction of an ongoing bull market or identify the start of a new bear market. Right now all three are well above rising 200 day moving averages, the most bullish configuration possible. All bull markets eventually end. The question is where and when will this one end?
The bottom indicator shows the ratio of U.S stock market capitalization to nominal U.S GDP. The historical high (showing overvaluation) was reached at the peak of the dot com boom in the year 2000. At the moment this indicator is still at a level which shows a very overvalued U.S. stock market. But is this necessarily the harbinger of an imminent bear market?
My own guess is that it is not.
This bull market started in March of 2009 and has lasted nearly eight years now, an unusually long time. True, there was a 23% drop in 2011 and a 16% drop in 2015-16 but both were very brief and hardly qualified as real bear markets - these typically last at least 8 months and drop the averages 25% or more.
The unusually duration of this bull market should be attributed to an ongoing expansion of world central banks' balance sheets with the Bank of Japan leading the parade followed by the Fed, the Bank of England, and the European Central Bank. This amounts to a vast jump in the liquid asset portion of the world-wide asset portfolio. This in turn was necessary because the 2007-09 financial crisis caused a huge increase in the demand for "safe" assets. Had the central banks not accommodated this demand stock and bond prices would have collapsed completely and a world-wide depression as bad as 1929-32 would have begun.
But I think the collapse in confidence, which necessitated this expansion of central bank balance sheets to accommodate the big increase in the demand for safe assets, has been reversed. One reason for this conclusion is the recent doubling in the U.S. treasury 10 year note yield (second chart from bottom). I think this rise in yield means that investors see stronger economic growth and higher inflation ahead. Both are stimulants to business investment and a stronger economy. Remember that low interest rates are signs of expected economic weakness, not of strength, and this rally in rates is a sign of a stronger economy going forward, not of a weaker one.
This revival of confidence means that the demand for liquid, safe assets is gradually falling after increasing dramatically for more than 7 years. The last time bond yields were as low as they were in 2016 was in 1946. Then too there was an enormous surplus of liquidity, not on central bank balance sheets but instead on consumer and business balance sheets. The result was a 20 year bull market which multiplied the Dow 5 times.
But there are two big differences between 2016 and 1946. First, in 1946 the "Buffet indicator" was well below 100% and thus showed a very undervalued stock market. Second, liquidity in 1946 was on the balance sheets of consumers and businesses, not central banks, the point being that central banks can reduce the size of their balance sheets at will and thus reduce economy wide liquidity.
Central banks generally follow the market rather than leading it. So even though I think central bank balance sheets will shrink during the next few years this shrinkage is likely to be very gradual. Meantime the drop in the demand for safe assets will fall more quickly and this will cause the prices of risky assets like common stocks to be bid up above current levels, thus reducing the percentage of liquid assets in the world portfolio in the direction investors desire.
In the posts I linked to above I suggested that a reasonable upside target for the S&P would be 2700. The analogous target for the Dow would be 23,000. I still think these targets are reasonable.
From a technical point of view I see the February 2016 low points as the start of one of George Lindsay's basic advances. These typically last 21-24 months which would suggest a bull market top in early 2018. A Lindsay 15 year 3 month period from bear market low to some subsequent bull market top ends in January 2018 when started from the October 2002 bear market low.
Put together these considerations suggest a bull market top at 2700 in the S&P 500 and 23,000 in the Dow sometime in early 2018.