The indicator alone does not signal that markets are ripe for a crash, rather that equity market valuations relative to economic output are as rich as they have ever been. Other factors in the economy, however, are showing signs that equity markets may be reaching a point of correction.
There has been divergence developing lately between SPDR S&P 500, SPDR S&P Homebuilders (XHB) and iShares Russell 2000 Index (IWM). As S&P 500 has continued to push towards new highs, both homebuilders and small-cap equities have lagged behind, while forming bearish technical patterns on their long-term charts.
If weakness persists in both small-cap equities and homebuilders, then sentiment could be adversely affected. Similarly, if the Fed chooses to raise interest rates in the first half of 2015, this could create a catalyst for both indexes to move sharply lower, bringing global equities down with them.
At the time of publication, the author held no positions in any of the stocks mentioned, although positions may change at any time.
This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.