Are These Reliable Signs That the Stock Market Is Topping?

Detail of a clock counting down, with only a few seconds to go till midnight

Investors are always worried about the next big stock market retreat. And that leads to a lot of prognosticating and theorizing about what the best signals are that a bull market has run its course. Pointing toward anecdotal evidence, like celebrities touting stocks, is one oft-quoted tell. But is it accurate?

Heck no!

Let’s back up a little.

This weekend I was poking around the internet catching up on earnings reports when I came across news that Tesla (TSLA) had just released a limited run of 200 surfboards, costing $1,500 each. Apparently, they sold out in just a few minutes, and a few have shown up on eBay going for more than twice that amount.

My first fleeting thought was that the price didn’t actually sound that outrageous. While most surfboards go for far less, it’s also not hard to spend well over $1,000 for a custom-made or low-production run board, especially if it’s made with premium materials.

My second thought was that this could be interpreted as a sign of a company straying so far from its core competency that it’s a bearish sign for the stock. Sort of like a derivative of the idea that when we see celebrities straying too far from their core competencies and begin touting stocks that the broad market has no way to go but down.

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With time to spare, and the preconceived notion that celebrity stock market bulls and corporate marketing collaborations have absolutely nothing to do with where a stock or the broad market will go, I went down the rabbit hole to see what celebrity trades I could find, and how they’ve worked out.

This is what I found.

Three Not-So-Reliable Signs the Market Will Fall

Mila Kunis Rotates from Cash to Stocks: CNBC ran this story on March 15, 2016, after the former That ‘70s Show actress appeared in an interview saying she had begun investing more in stocks. Social media blew up, with many saying this was surely a sign of a stock market top. An alternative perspective—that maybe she just realized that cash in the bank loses value over time due to inflation and that a team of advisors suggesting she consider the stock market instead is actually good advice—wasn’t easy to find. At the time, Mila Kunis was 33 years old. And any financial advisor worth listening to would advocate she be invested in stocks. The S&P 500 Index is up 41% since.

Here's what the stock market has done since Mila Kunis started investing in stocks.Gisele Bündchen Asks to Get Paid in Euros: In 2015 MarketWatch featured a story about how, in August 2007, Gisele Bündchen had requested that Proctor & Gamble pay her in euros for a photoshoot featuring Pantene products. The reason, of course, was that the value of the dollar was declining relative to the euro so it seemed to make sense at the time to get paid in euros instead. MarketWatch went on to point out that the dollar index bottomed out in March, just seven months later, and suggested that Bündchen’s appetite for the euro may well have signaled its peak.

Here’s an alternative theory. Bündchen didn’t act alone in making this decision and actually received good advice. The dollar index continued to decline until early 2008 then spent the next six years trading both above and below where it was at the time of Bündchen’s supposed request (see chart below; the green line is the approximate time of her photo shoot). It didn’t break out in earnest until the middle of 2014, seven years later. The model had both ample time to either spend the money or invest it in some other vehicle before the “trade” went south. In any event, her request was far from a reliable tell of how to trade currencies over the following months.

Kanye West Gifts Stocks to Wife Kim Kardashian: In July 2018, CNBC reported that Kanye West had given wife Kim Kardashian five stocks for Christmas in 2017. The stocks were Netflix (NFLX), Amazon (AMZN), Apple (AAPL), Adidas (ADDYY) and Disney (DIS). Given that those stocks have done well since, the headline, “Kanye West Beat the Market by More Than 40 Percent” hasn’t elicited calls that Kanye’s gift was a sign of the market top. But if they hadn’t outperformed, it surely would have!

Each stock has beaten the S&P 500’s return of 6.5% since Christmas. Netflix leads with a gain of 87%, while Amazon, Apple, Adidas and Disney are up 59%, 21%, 9% and 8%, respectively. The message here isn’t to follow Kanye West into whatever his next well-publicized trade is, but that, as with other high-profile celebrity trades, I’m willing to bet Kanye didn’t act alone. And I wouldn’t read too much into it.

The bottom line here is that I don’t think it’s wise to rely too much on anecdotal evidence, and especially what celebrities are doing, for signs of where the stock market is going to go next. These types of stories are great conversation starters, whether online or at a cocktail party, but that’s about it.

Three Reliable Signs of Where the Stock Market Will Go

The unfortunate truth is there’s no single indicator of what the market will do. There are, however, several trends and/or indicators you can follow to increase your odds of being on the right side of the market over the long term. Mind you, these aren’t as effective as talking about celebrity trades when trying to strike up conversation at a cocktail party. But they’ll probably help you manage your portfolio a lot better. Here are three trends you should follow.

Profits and Profit Margins: Companies that are making money hire more workers, invest in new technologies and infrastructure, acquire other companies, pay taxes, provide reliable income and benefits to employees and, over time, grow into bigger companies. These are all good things for the economy and the stock market, so keep an eye on trends in profit margins in the broad market, as well as individual sectors and the stocks that you either are, or want to be, overweight in.

Forward Earnings: Forward earnings are probably the best indicator of where the market is going because they, along with the relevant ratios like the forward-price-to-earnings ratio (PE), tell us if and by how much profits are expected to grow (or shrink), and how much the market is willing to pay for those earnings. The caveat is that the underlying estimates need to be accurate! And that’s where things can get a little squirrely since consensus estimates are often overly bullish during expansion phases. On the other hand, relying only on trailing earnings, which are more reliable since they’re already in the book, often paints an overly conservative picture, especially during bear markets. In short, place a heavy weighting on forward earnings estimates, but take them with a grain of salt and allow room for your own analysis and perspective to factor into the equation.

Inflation: It’s not hard to find an economist or market observer touting inflation as a key component of any market analysis. In very simple terms, we want measured increases in inflation, typically in the 2% to 3% range. We do not want rapid increases or decreases, and certainly don’t like rapid, unexpected changes since these tend to signal major issues that will likely impact stocks.

One reliable source for analysis and commentary on inflation is Dr. Ed. Yardeni, who writes, “Accurately predicting price inflation is one of the most important prerequisites for predicting the outlook for the stock and bond markets.”

Here’s a look at a chart from his website showing historical inflation and major market events.

Dr. Yardeni’s take is that the current rate of inflation is not a concern for stocks. He sees the lukewarm inflation environment as a good backdrop to help the Fed keep up the gradual normalization of monetary policy. Another take on inflation, from Cullen Roche at Pragmatic Capitalism, is that the likelihood of a high inflation rate is low since, “… macro trends are putting an extreme amount of downward pressure on that potential outcome”.

Looking at profit margins, forward earnings estimates and the current inflationary environment is likely to work far better for you than studying celebrity trades. Yes, it’s comparatively boring (I enjoyed writing the first half of this article far more than the second half!)

But let’s be honest: when you’re trying to grow your wealth over the long term you don’t want to rely on the relatively opaque trades that a select few high-profile people may or may not have made. You’re far better off sticking with the less exciting, but far more reliable evidence that ties into how the real economy, and real companies, are doing. And Cabot Small-Cap Confidential can help you with that.

For more information, click here.

Tyler Laundon

Stocks That Can Make You RICH

Tyler Laundon is chief analyst of Cabot Small-Cap Confidential. The circulation of Small-Cap Confidential is strictly limited because the undiscovered stocks with sky-high-potential that Tyler recommends are often low-priced and thinly traded. Don’t share these recommendations!

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