The Market Peak Is In
Summary In April I wrote an article that predicted the conditions necessary for a market peak to have occurred. In August these conditions were met. I detail some investment options to consider if a peak has in fact been made. In this article, I will be explaining why I believe the market has peaked or will peak soon, which means this bull run is over. In an article I wrote in April titled ” Constructing A Market Peak Blueprint ” I detailed three metrics that when combined have predicted the end of the previous two market tops in 2000 and 2007. The metrics I looked at were the monthly S&P 500 (NYSEARCA: SPY ) Shiller PE ratio, high-yield bond spreads and interest rates. In the final paragraph, I noted, “While none of these metrics currently are near a point at which all three will align to predict a top, it is still something that investors can watch for in the future. Well, the future I talked about in my article is now! I never like being the bearer of bad news, however since I wrote my article, all three metrics have aligned to the specifications I laid out in my article. That is why I am predicting the market peak is in. Market Peak Conditions The conditions needed to be met to declare a market peak are the following conditions listed below. I collected Shiller PE data from Multipl.com , High-Yield Spread data from the St.Louis Federal Reserve and historical interest rate data from Yahoo Finance . [Note all data is monthly] As the data in the tables below show that in August, all of these conditions were met. Shiller PE of greater than 25 Shiller PE declines 4 Months in a row High Yield Spreads Increase 4 Months in a row 10-year Interest Rate decreases 3 Months in a row Shiller PE High Yield Spreads 10-Year Interest Rate May 26.87 May 4.51 May 2.10 June 26.62 June 4.66 June 2.34 July 26.55 July 5.11 July 2.21 August 26.54 August 5.66 August 2.20 Previous Peaks There have been three previous times in the last fifteen years where these conditions have all aligned and those were in November & December 2000 and August 2007. This can be seen graphically in the following two monthly charts, which show the point at which the conditions were triggered. (click to enlarge) (click to enlarge) [Charts from ThinkorSwim Platform] What can investors do? -Don’t Panic! The number one thing is not to panic if the market peak is in. I am in no way saying to go out and panic selling. However, as I detail below, there are some investment actions investors can make to lessen the pain if a market peak has already occurred and a major correction follows. Investment Option #1: Get Defensive With ETFs, investors have a number of choices that are quality ETFs that own defensive equities. The PowerShares S&P 500 Low Volatility Portfolio ETF (NYSEARCA: SPLV ) is attractive because it holds stocks with the lowest volatility in the S&P 500. The Guggenheim Defensive Equity ETF (NYSEARCA: DEF ) is attractive because it holds fundamentally strong, dividend paying companies that have a history of outperforming according to its Fact Sheet . “DEF uses a rules-based quantitative approach, the index selects stocks based on fundamental characteristics such as a strong balance sheet, dividend payments, conservative accounting practices, and a recent history of out-performance during weak market days.” The Barclays ETN+ VEQTOR S&P 500 Linked ETN (NYSEARCA: VQT ) or the PowerShares S&P 500 Downside Hedged Portfolio ETF (NYSEARCA: PHDG ), which both dynamically allocate between stocks, VIX futures & cash. The following chart from the VQT prospectus shows that in late 2008, the allocation to volatility was increased which is shown by the steep increase in the index value. [Chart from VQT Prospectus] Investment Option #2: Add a short position to hedge downside risk The two main options for shorting the overall market are the ProShares Short S&P 500 ETF (NYSEARCA: SH ), which is the DAILY inverse of the S&P 500. The second option is the AdvisorShares Ranger Equity Bear ETF (NYSEARCA: HDGE ), which is an actively managed short ETF. Investment Option #3: Consider Adding Precious Metals During the large decline in the market two weeks ago, gold (NYSEARCA: GLD ) & silver (NYSEARCA: SLV ) performed quite well because of investors seeking safety. For those looking for investment choices in the precious metals space there is obviously the GLD or SLV or there is the broad ETFS Physical Precious Metal Basket Trust ETF (NYSEARCA: GLTR ), which holds physical gold, silver, platinum & palladium. Investment Option #4: Employ a barbell approach Investors can employ a barbell approach where they own short-term fixed income to preserve capital and generate some income and high quality growth stocks. The PIMCO Enhanced Short Maturity Strategy ETF (NYSEARCA: MINT ) is an actively managed ultra-short term bond ETF designed to generate above money market returns and is a good capital preservation tool. In addition, if you still want capital preservation but are looking for a higher yield, a quality choice is the Vanguard Short-Term Corporate Bond Index ETF (NASDAQ: VCSH ), which invests in short-term investment grade corporate bonds and currently yields just less than 1.90%. For the other end of the barbell, investors can look for high growth companies that have growth and have minimal debt. For example, earlier this year I wrote an article , where I determined it was the number one stock in the world was Visa (NYSE: V ). I determined Visa was the number one stock because they have $4.7 billion in cash, no-debt, they pay a dividend, is expected to grow earnings 17.74% over the long-term, is buying back shares and in 2016 they start their new deal replacing AMEX (NYSE: AXP ) at Costco (NASDAQ: COST ). Other quality stocks like Gilead Sciences (NASDAQ: GILD ), which have strong balance sheets and clear growth drivers, should be considered when using the barbell approach. Closing Thoughts If a market peak is in fact in, investors need to be mindful and give extra scrutiny to investments for their potential performance during a down market. If a market peak has occurred, as I highly suspect that it has, individual stock selection and/or tactical allocation to ETFs is something that will become extremely important. This kind of environment is where great investors shine. I do not know who said the following quote but it applies to this situation and it goes something like “Anyone can be a good investor in a bull market, however, what separates good investors from great investors is bear market performance.” Disclaimer: See here . Disclosure: I am/we are long SPLV, GILD. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.