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

• Ned Davis Research says investors should watch for signs of a potential top in the S&P 500.

• The secular bull market, which began in 2009, is in a mature stage, according to NDR’s Tim Hayes.

• “As the secular bull matures, we are alert for signs that it may be in danger,” he said.

With the S&P 500 in its 15th year of a secular bull market that began in 2009, Ned Davis Research says investors should be on the lookout for warning signs of a potential top.

In a note on Friday, NDR Global Chief Investment Strategist Tim Hayes said the secular bull rally is in its mature stage, so investors should be on the lookout for warning signs like extreme sentiment.

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

He added: “The risk is that a lack of risk aversion leaves investors exposed to a degree of sustained macro deterioration not yet experienced since the beginning of the bull run.”

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

“The last two secular bulls lasted 24 years (1942 to 1966) and 18 years (1982 to 2000). But as the secular bull matures, we are watching for signs that it may be in danger,” Hayes said.

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

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

Investors needn’t worry that this signal is flashing just yet, with recent data showing an increase 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 pretty quickly.

“Expensive valuations seem justified when earnings growth is realized, but that leaves the market vulnerable when earnings fall,” Hayes said.

Long-term peaks in the stock market usually occur when earnings growth and economic growth reach extreme levels, because the other side of that boom is usually a rapid 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 fell on the growing realization that valuations were not justified,” Hayes said.

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

“The current level of earnings growth has not yet reached the peak levels of 1929 and 2000, but it has already approached the levels of 1966,” Hayes said.

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

Finally, Hayes said investors should keep an eye on bond and commodity yields 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 rally in stocks.

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

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