6 Ways To Tell If The Market Is About To Crash
Let's assume you think the stock market is about to stumble, and stumble badly.
How can you see the top coming?
Some argue the top is already staring everyone in the face. The Dow Jones industrials were up 21.15 percent for the year as of Thursday's close, with the Standard & Poor's 500 Index up 25.6 percent and the Nasdaq Composite Index up some 31.6%.
Since the 2009 market bottom, the Dow is up 143 percent, with the S&P 500 sporting a 165-percent gain. The Nasdaq, meanwhile, has jumped 213 percent.
But that doesn't necessarily mean a top is near. In fact, the Dow produced gains every year from 1991 through 1999. The S&P 500 and Nasdaq were up eight of those nine years.
But by the end of that run, it was clear to a lot of people that trouble was brewing, thanks to what can only be described as insanity in tech stocks. The dot-com bubble sent the Nasdaq soaring nearly 86 percent in 1999 alone, and 571 percent between the end of 1994 and 1999. Anyone with even a hint of an idea could launch an IPO.
The aftermath, as we all know, was horrible. The Nasdaq peaked in March 2000 and then fell 78 percent over the next two years. It's still more than 1,000 under its 2000 peak.
Besides huge gains, a number of indicators can suggest -- but not guarantee -- that a slump is just around the corner. Here are some of the most useful:
Relative Strength Indexes. A relative strength index is an esoteric measure of momentum, but it's watched carefully. You can find them in the charting tools of most major websites. A 14-day RSI is the most common measure. If it is above 70 or 75, the stock or index is likely overbought. If it is below 30, it's oversold.
When the market peaked in in late 1999 and the first quarter of 2000, the Nasdaq's RSI reached as high as 86. That was a screaming sell signal.
After the Sept. 11, 2001, terror attacks the Nasdaq's RSI fell to as low as 15.4 -- a screaming buy signal, but not a perfect buy signal. The Nasdaq actually fell an additional 26 percent before a bottom held in October 2002.
On Thursday, the RSIs for the Dow and S&P 500 were about 66, close to an overbought level.
Moving Averages. These are simple ways to look at price compared with a longer trend. 50-day and 200-day moving averages are useful. The first offers a quick sense of investor confidence. The 200-day moving average (some prefer a 150-day average) suggests longer-term direction. A stock moving 10 percent or more above its 200-day moving average is suggest an overbought condition. If a stock or index falls below its 200-day moving average, it is bearish. In March 2009, the Dow, S&P 500 and Nasdaq were all trading 30 percent or more below their 200-day averages, clear buy signals.
On Thursday, the Dow closed nearly six percent above its 200-day average, with the S&P 500 9.4 percent higher than its 200-day average. The Nasdaq finished 13.2 percent above its 200-day average. The Nasdaq is saying it's getting toppy.
Price to Earnings Ratios. The standard price earnings ratio measures a price of a stock against earnings. The higher the P/E ratio, the pricier the stock or index. It makes sense. You can look at the price-earnings ratios for indexes as well.
The Dow was trading at 17.8 times the past four quarters of earnings of its 30 components, according to The Wall Street Journal on Friday. That was up from 13.7 times its earnings a year ago. The S&P 500 is trading at 18.7 times earnings. The Nasdaq-100 Index is trading at 21.5 times earnings. At the very least, the ratios are signaling that stock prices are rich.
Take a look at Robert Shiller's "Cyclically Adjusted Price Earnings ratio" or CAPE. Shiller, a co-winner of this year's Nobel Prize for Economics, looks at the level of the S&P 500 compared with a 10-year average of its price earnings ratio adjusted by the annual change in the consumer price index. (Whew!) But here's why people are paying attention to it. Shiller's data goes back to the 19th century. As of Nov. 1, his CAPE index was at 24.4. How high is that?
Before the dot-com bubble burst in 2000, the index had hit 43. It was at 27 in 2007, before the market crash, and it was above 31 in 1928 and 1929, before the great stock market crash hit.
The Bond Market Will Have its Say. When Federal Reserve Chairman Ben Bernanke suggested this past spring that the Fed might taper its big bond-purchasing program, interest rates promptly moved higher. Housing activity slowed, the economy seemed to lose its early-year mojo and stocks struggled.
Pushing rates higher wasn't Bernanke's intent, but often you can't control how traders view a policy change. The Fed and interest rates will play a dominant role in how stocks and the economy perform in the next year. If the 10-year Treasury jumps to, say, 3.5 percent, stocks could be pressured.
The 10-year Treasury yield was 2.71 percent on Friday, up from 1.63 percent on May. The yield was at four percent as the crash year of 2008 began.
Housing Isn't the Problem. A good argument to suggest a crash is not imminent is housing starts. The Commerce Department tells us that starts hit a seasonally adjusted annual rate of 2.27 million units in January 2006, just as the housing bubble was peaking. In August 2013, the starts rate was 891,000 units; that is, single-family homes, townhouses or apartments. Yes, housing has been recovering: Starts are up roughly 20 percent from a year ago. But the U.S. market is nowhere near a bubble.
The Ishares Dow Jones U.S. Home Construction exchange-traded fund (NYSE: ITB), which tracks home builders, jumped 12.9 percent in the first quarter, but worries about economic softness have trimmed the gain to around seven percent.
Never Underestimate Oil Prices. The 2008-2009 recession wasn't due just to the real estate bust and the near-collapse of the banking system. The economy, especially the auto makers, were badly hurt by soaring gasoline prices. The national average price of gas topped $4.11 a gallon in July 2008 as crude oil hit $147.27 a gallon.
While gasoline today averages about $3.20 a gallon nationally, it nearly reached $4 in the spring of 2011 and early 2012 -- and hit $3.80 in 2013 as crude oil climbed higher on Middle East tensions.
Gas-price increases are a tax on consumers, and they responded by trimming spending elsewhere. Gas prices are now at two-year lows, and consumer discretionary and airline stocks have been among the year's top performers. Netflix (NASDAQ: NFLX), Best Buy (NYSE: BBY) and Delta Air Lines (NYSE: DAL) are three of the top four S&P 500 performers this year.
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