Predicting the next bear market in 6 charts

Here are some clues investors are using to see if the long bull run is nearing an end.

  • By Riva Gold,
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Nine years, seven months, four weeks and two days into the current bull market, some investors are asking whether a bear is on the horizon.

The S&P 500 (.SPX) is up 307% since the bull market began in 2009. Stock prices have powered forward thanks to robust earnings growth. Investors have also been willing to pay a higher premium for those earnings, as seen in expanding price-to-earnings ratios.

While there is no single indicator that can predict market turns on its own, here are six things analysts and investors are watching to see if the next bear market, typically defined as a 20% decline from a recent peak, is around the corner.

We may already be part of the way there. The S&P 500 is 5.98% off its all-time high reached Sept. 20, 2018.

1. High-yield bond spreads

What it is

A measure of what riskier companies pay to borrow compared with what the government pays. These high-yield bond spreads have historically picked up signs of economic stress earlier than other assets. When spreads are tight, investors tend to think that even the weakest companies will be fine. When they are wider, it is harder for these companies to access loans, crimping profits and signalling that investors believe defaults are on the horizon.

What to watch

A steady trend higher in high-yield bond spreads accompanied the last two stock market peaks. It signaled that investors were getting wary about riskier companies’ ability to pay back debts.

2. Yield curve steepness

What it is

The yield curve is one of the most closely watched indicators of the stock market’s health, measuring the interest rates paid on debt of various maturities. When the economy is strong, the yield on long-term government bonds is typically higher than on short-term debt, reflecting confidence in the long-term economic outlook. When the yield curve inverts, and short-term yields surpass long ones, it’s a sign investors are worried that inflation—and growth—will be low in the future. High short-term rates tend to crimp business and consumer spending, slowing the economy and putting pressure on corporate profits.

What to watch

Inversions often precede recessions and bear markets for stocks. This measure did not invert until after the 1987 bear market, but did precede the bears of 1980, 2000 and 2007. Investors are staunchly divided over whether an inverted yield curve on U.S. Treasurys can still signal a bear market, or whether rates have been distorted by years of unorthodox global monetary policy that keep yields on long-term debt low.

3. Deal activity

What it is

The total dollar value of mergers and acquisitions by month.

What to watch

A big pickup in deal activity has historically come toward the end of bull markets. A jump in mergers can signal that sentiment has turned excessively optimistic—or that companies see it as the only way to grow as the economy decelerates. Mergers and acquisitions spiked in 2000 and 2007 shortly ahead of the stock market peaks in a sign of excessive risk-taking. More recent peaks have been false alarms, though a spike at the end of 2015 was followed by a stock market correction that fell short of a bear market.

4. Weekly jobless claims

What it is

A weekly count of people filing to receive unemployment insurance benefits. Market participants view the figures as a key leading indicator of the U.S. labor market, the health of the broader economy, and thus the ability of companies to generate cash.

What to watch

When unemployment rises, consumers spend less money, which crimps what companies take in. Analysts suggest looking for a consistent rise in jobless claims after a steady period. If this happens at the same time as weakness in the monthly U.S. jobs report, it is an ominous sign for the economy.

5. Investor sentiment

What it is

The AAII survey is a barometer of American retail investor sentiment that asks participants to predict the direction of the S&P 500 over the next six months.

What to watch

Look for extreme highs and lows of investor bullishness, says Charles Rotblut at the AAII. When investors get too optimistic, they tend to run down their savings and overspend. There’s typically less cushion to protect the market, allowing selloffs to gain momentum. This measure worked very well just before the dot-com bubble burst, and spiked just before selloffs in 2011 and 2018.

6. What the market thinks

What it is

Think of this as the market crowd sourcing predictions of a bear market. As measured through options expiring in roughly six months, it is the estimated probability of a 20% or more drop in the S&P 500, the typical definition of a bear market. Economists at the Federal Reserve Bank of Minneapolis found indicators like this useful as a gauge of current expectations for future prices, but it’s really more a measure of what investors think right now than a predictive indicator.

What to watch

A relatively new measure, this chart spiked during the financial crisis and rose sharply during other recent episodes of market stress, including the 2016 China growth scare that sent markets tumbling.

Note: The charts above include two recent periods commonly considered by investors to have been bear markets. Some market technicians say that the March 2000 bear market briefly paused between September 2001 and January 2002, during which a small bull market occurred. Similarly, some analysts say the 2007 bear market technically ended in late November 2008 before another bear market took shape in January 2009.

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