Watch these warning signs for a potential peak in the stock market’s long-term bull rally, NDR says

With the S&P 500 in its 15th year of a secular bull market that started in 2009, Ned Davis Research says investors should watch for warning signs of a potential peak.

In a Friday note, NDR chief global investment strategist Tim Hayes said the secular bull rally is in its mature stage, so investors should keep an eye out for warning signs like sentiment extremes.

“What will warn that it’s ending? The answer comes down to sentiment — so much positive news for so long that it has become the new normal,” Hayes said.

He added: “The risk is that the lack of risk aversion would leave investors exposed to a degree of sustained macro deterioration yet to be experienced since the bull got underway.”

Hayes isn’t calling for an imminent peak in the stock market, especially with falling interest rates historically acting as a tailwind for stock prices, but he’s aware that it could happen.

“The last two secular bulls lasted 24 years (1942 – 1966) and 18 years (1982 – 2000). But with the secular bull mature, we’re watching out for signs that it may be at risk,” Hayes said.

The first warning sign of a near-term peak in the stock market is worsening breadth among the underlying issues of the US stock market.

In other words, if only a handful of companies drive the stock market higher, that would be a bad sign, as it was at the secular top in 2000.

Investors don’t have to worry about that signal flashing just yet, with recent data showing a surge in market breadth.

Extreme valuations would be another warning sign to watch for, according to Hayes, who added that high valuations price in a perfect macro environment, and if something goes wrong, those valuations can fall apart rather quickly.

“Expensive valuations appear justified when earnings growth is coming through, but that also leaves the market vulnerable when earnings turn lower,” Hayes said.

Long-term peaks in the stock market also typically occur when earnings growth and economic growth hit extreme levels, as the other side of that boom is typically a swift deceleration in growth.

The secular stock market peaks of 1929, 1966, and 2000 all coincided with a peak in S&P 500 earnings growth, “after which prices dropped on the growing realization that the valuations were not justified,” Hayes said.

While valuations and earnings growth are currently at high levels, they could have more room to grow, according to the note.

“The current level of earnings growth has yet to reach its levels at the peaks in 1929 and 2000 but has already closed in on its levels of 1966,” Hayes said.

He added: “For a downturn in earnings growth, we would expect to see a downturn in economic growth.”

Finally, Hayes said investors should keep an eye on bond yields and commodities, as they will reflect a potential rebound in inflation. And a rebound in inflation, coupled with rising interest rates, would be an unwelcome warning sign for the current bull rally in stocks.

“If that would start to change with a severe cyclical bear, the secular bear warnings would strengthen, and we would be likely to see reversals from extremes in valuations, earnings growth, and economic performance,” Hayes concluded.