Signs of a Top?

12/17/2013 9:00 am EST

Focus: STOCKS

Joon Choi

Senior Portfolio Manager, Research Analyst, Signalert Asset Management LLC

Although cycles do not give an exact inflection point for when a bull market will come to an end, they tend to be in the ballpark. Comparing the current bull market to that of the 2002-2007 market cycle suggests caution, says Joon Choi in Systems & Forecasts.

First, here's a recap of my recent comments on why we may be nearing a stock market top.

Corporations in the US have been buying back their shares at an alarming rate. The primary reasons for the buybacks are to increase the underlying share price, and to decrease the number of outstanding shares so companies will be able to engineer artificially higher earnings per shares.

Even with falling earnings, a company can manage a higher EPS if it buys back significant shares of its company.

Moreover, only 52% of S&P 500 Index (SPX) members were able to beat the analysts' estimates for the third quarter, far lower than the 70% average. In short, US companies are not doing as well as stock prices would suggest.

Also, initial public offerings have been rising in recent years and companies have raised $49.4 billion from IPO's so far this year—which is higher than the $48.7 billion raised in 2007. IPO activities tend to top out during stock market tops, as it did in 2000 and 2007.

Stock market lows were made in September of 2002 (based on monthly close) and the highs were made 61 months later in October of 2007.

February of 2009 was the stock market bottom for the recent bear market and 61 months later puts us at March of 2014. Thus, if the current bull market resembles the previous one, then the stock market top is only a few months away.

Uncertainty surrounding the debt ceiling debate (February 8, 2014 deadline), and the possibility of the Fed tapering off bond purchases, may lead to more volatility in the first quarter of next year.

Meanwhile, our proprietary models indicate that we are in a favorable environment for equities. However, I want to reiterate that a 5% sell-off in the equity market may turn into a double-digit correction.

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