The 10 Signs of a Market Crash: But It May Not Be Time to Bail on Stocks

You can protect your money by heeding these tell-tale signs of a market crash.
By John Persinos ,

In today's jumpy investment climate, listening to the warning signs of a market crash is more imperative than ever. To prevent getting blindsided, you need to pinpoint the troubling trends ahead of time.

Below are 10 key indicators that can help you determine whether markets remain relatively safe or are about to collapse.

1)The indices continue to rise but the number of 52-week highs begins to decline.

If the number of 52-week highs declines, this means fewer stocks are working to push the market upward.

If you looked at all the individual companies in the S&P 500at the end of October, you'll see that more than 400 of them were down at least 10%; about half were down 20% or more; and more than 100 companies were down 30% or more from their 52-week high price. That's a red flag.

2) The major indices move below a previous "swing low."

Swing low refers to the troughs reached by an indicator or an asset's price. A swing low occurs when a low is lower than any other point over a certain time period. Successively lower swing lows means that the underlying asset is in a downtrend; higher lows mean it is in an uptrend.

When the market is an upward trajectory, share prices hit higher highs and higher lows. Consequently, when prices neglect to post higher highs, or forge a lower low than the previous low in the uptrend, the uptrend has run out of gas. The S&P 500's near-term direction remains congested at the 2,100 level, another ominous sign.

3) Extremely high trading volume and volatility.

This symptom enriches brokers and generates a lot of paperwork at brokerages, but it's often a sign that the market is getting frothy. In an overheated market, brokers tend to churn 'em and burn 'em, racking up fees for themselves.

And the markets have certainly experienced bouts of extraordinary volatility. Notable case in point: August 24, now dubbed "Black Monday," witnessed the biggest market decline in recorded history.

At one point on that day, the Dow was down 1,000 points. In successive weeks, the steep drop has been followed by roller-coaster rides that are leaving investors dizzy. And yet, following the big dips in August, September and November, the markets lately have moved sideways.

4)Valuations are off the charts.

It's a warning bell when valuations are at historical extremes in terms of price-to-earnings (P/E) ratios, dividend yields, book values and corporate earnings.

The average trailing P/E ratio since the 1870s has been about 16, roughly where the S&P 500's average P/E stands today, which indicates that reasonably priced stocks can still be found. That said, make sure you don't fall for the siren's call of sexy but overpriced and dangerous stocks with valuations that simply don't justify growth prospects.

5) Bad breadth.

No, I'm not referring to halitosis. A sign of a market peak is when fewer and fewer stocks are participating in the upswing. It usually means that the major indices are lurching toward their final climax.

Specifically, it's a bad sign if the NYSEadvance/decline has peaked and is now declining, although the S&P 500 and Dow Jones Industrial Average continue higher. This dynamic indicates that although the selective market indices are rising, the much broader market is foundering. It indicates that overall market performance is being driven by a minority of companies.

This past week, an increasing number of analysts are expressing bearish concern about the deteriorating breadth shown by the NYSE advance-decline line, which has been reflecting a series of lower highs and lower lows.

6) The Fed is getting stingy.

When the Federal Reserve increases interest rates and squeezes credit, it causes money supply growth to nosedive, an unmistakable sign that the stock market will soon stall. Historically, money supply growth has exhibited a close correlation with stock price movements. An increasing money supply boosts stocks; decreasing money supply puts the brakes on stocks.

So, with the Federal Reserve poised to raise rates next month, should you be worried? In this case, not really. Analysts have endlessly discussed the inevitability of tightening and the markets seem braced for it. The fallout should be modest.

7) When "distribution days" are packed into a short amount of time.

A distribution day is the term for a down day in the market on heavier than usual volume. When the stock market has a half-dozen distribution days within, say, a 2-4 week time period, it means the market is getting wobbly. This phenomenon occurred in the turbulent months of August, September and October.

8) The market leaders are losing steam and laggards become the leaders.

Rallies often are propelled by a relatively small number of strong stocks that are "market leaders." When these stocks begin to falter, it could mean that the rest of the troops will follow.

By the same token, it's another warning sign when weak industries lead the charge. If breadth is weak leading into rallies, and the laggards take the helm as leaders, you should worry. Case in point: Despite persistently low energy prices that will continue to scrape bottom in the foreseeable future, the Vanguard Energy ETF has risen nearly 15% over the past three months, whereas the S&P 500 over the same period has risen about 11%.

9) Overwhelmingly bullish consensus among analysts and advisers.

When the stock market crested in 1987, 2000 or 2008, were you caught up in the euphoria and did you get burned? Don't fall for "group think" and buy vulnerable stocks that are poised for a fall. When analysts and investment newsletters are all caught up in the bullish euphoria, it's time to cool it and reduce exposure to stocks.

But the fact is, bearish sentiment is rising, which paradoxically can be construed as a contrarian indicator, because it means that the markets haven't succumbed to irrational exuberance.

10) Signs of economic slowdown in cyclical industries.

P/E ratios for high-flying cyclical stocks can be deceiving. During prosperous times, companies in the auto, home building, steel, and retail industries report huge profits that propel their P/E ratios to nosebleed heights. However, as soon as economic conditions in these sectors start to sour, their stock prices plummet. The fact is that many cyclical sectors, especially auto stock leaders such as General Motors and Ford -- are doing well and report record sales.

Based on these 10 indicators, should you run for the hills? Not just yet. Stick to "defensive growth" stocks that convey appreciation potential but will weather downturns along the way. And in the coming weeks, keep an eye on these time-tested indicators.

Many popular but dangerous stocks are widely held in retirement portfolios, but they're about to collapse. To discover whether you own any of these terrible equities, click here for a free report.

John Persinos is an editorial manager and investment analyst at Investing Daily. At the time of publication, the author held no positions in the stocks mentioned.

Loading ...