Indicators of a Market Top

Market tops tend to have three characteristics in common, and only one of them is reflected in the current environment, according to a recent article in Barron’s.

The article cites comments by columnist Mark Hulbert, who refers to valuation metrics such as P/E, price-book, price-sales and price-dividend ratios as weak indicators of market tops but adds that we ignore them “at our peril, since it’s also true that almost all bull market tops in history have begun when they signal that the market has become overvalued.”

Other indicators are:

  • A “struggling” financial sector—The article cites Ned Davis Research data showing that, “During the last three months of all post-1970 bull market tops prior to 2007, the sector lagged the S&P 500 two-thirds of the time.”
  • An environment in which a relatively small number of stocks participate in the market gains, known as “divergences.”

“Fortunately,” the article says, “overvaluation is the only one of these three characteristics that’s present today. Stocks, on average, appear to be even more overvalued today than they were at the 2007 top, according to any of the standard valuation ratios.”