NEW YORK (TheStreet) -- "It's better to be out of the market, wishing you were in, than in the market, wishing you were out." -- Old Wall Street adage
This old bit of Wall Street wisdom has the most relevance after a sustained trend shows signs of maturity, as historic extremes are being tested or broken. Sound familiar? It should, as historic extremes are being made in this price zone and time period. Here are five warning signs that the bull market party has ended:
1. The kinds of companies filing initial public offerings. Near bear market lows, when buyers are afraid to buy, IPO-selling companies almost beg investors to "share the opportunity," offering bigger pieces of the company, and showing strong financials.
At both major lows of the past 25 years (2002 and 2009), the percentage of unprofitable companies going public was less than 2%, according to SentimenTrader.com. Near bull market highs, companies line up in record numbers to share the risk with outside investors, giving away smaller pieces of the pie, while showing weak financials.
According to SentimenTrader.com, the current environment has set a new record for the percentage of unprofitable companies doing IPO's. Around the 2000 peak, 76% of companies coming public were unprofitable. Around the 2007 peak, 65% of IPO's were of unprofitable companies. This year, a record high 78% of companies coming public are unprofitable. This is a huge warning sign that another major market peak is at hand.
2. The level of commitment of mutual fund managers. When committed to extreme bullishness, they leave little cash in their portfolios (believing there will be no meaningful correction to buy into). When extremely bearish, they increase cash levels to soften the current decline, and have money to buy into the bottom in the future. However, as you might guess, they get to these extremes after most of the trend-in-force has occurred, making them the ultimate contrary indicator, when other parameters line up to confirm.
For the past six years, mutual funds cash to asset ratio has been below 4%. The only other time in the history of the data (going back to the 1960s) is in 2007, for a few months. That didn't end well. This go around, however, sub-4% cash levels have persisted since late 2009. Furthermore, recent surveys of investment advisors show the current extreme is the most persistently optimistic since the 1960s, as well. The 200-week moving average of bearish advisors is nearing only 21%. At the 2007 peak, advisor bearishness only reached 24%, while at the 1987 highs, it reached 23%. This year's extreme is not only historic, but epic.
3. Lack of respect for professional money managers. Back in the late 1990's, the Beardstown Ladies Investment Club was on a book tour, appearing on financial television, as well as on the non-financial morning show circuit, bragging about how easy it was to beat not only the pros, but also the market. Following them through the dot-com bubble burst didn't work out well for most investors. The most recent occurrence of this phenomenon is the new television show called West Texas Investors Club. History never perfectly repeats, but it often rhymes. The rise to television status of the Beardstown "echo" has ominous implications for those who tune into the series.
4. Hindenburg Omen Crash Warnings. This indicator is a combination of technical factors that attempts to measure the health of the market. It's goal is to signal the increased probability of a stock market crash.
According to Bob McHugh, at Main Line Investors, there are now two independent Hindenburg Omen Crash Warnings "on the clock." Each has a four month window, once triggered, and the two current warnings don't expire until mid-September and mid-October. In the past 30 years, all but one crash of 15% or more have had a Hindenburg on the clock. McHugh states that while a Hindenburg doesn't guarantee a crash, it is a necessary precondition for a crash to occur. These warnings tell investors that the stock market is in a very fragile and dangerous condition. Most importantly, when a Hindenburg is on the clock, the odds of a market crash rise to a statistically significant 25%, far above random.
5. The "tout" effect. This is best captured by the Magazine Cover Indicator, made popular by economist Paul Krugman. Essentially, by the time an idea has had time to make its way to the business press, particularly a trading idea, then the idea has likely run its course. So, good news on the cover can be taken as a bad omen, while bad news should prepare the crowd for a turn higher.
With today's digital lifestyle, not as many people read actual magazines today as in the past. However, online magazine-like publications and other media can have the same effect. Last week, one of the most widely followed market gurus told TV audiences that the S&P 500 would hit 3200 in two years. Is this tantamount to past images of raging bulls on the covers of news stand periodicals? Only time will tell. But, with some of the other warning signs discussed above, perhaps an objective strategy of based upon playing defense is worth consideration.
On Friday, the Dow broke below its July low, joining only the Russell 2000 and the $Sox indices in that significant feat. As we wrote, in Friday's mid-day analysis, a bounce of several hours to several days was due (the Dow was at 17,300 when we submitted). Once the S&P 500 and Nasdaq confirm the Dow's break, with breaks of their own July lows, the peak will be in the history books, and the bulls will be appearing on the menus of bear luncheons. (For more on rational, data-based decision making in the markets, click here.)