This week we’re looking at a clear and present warning indicator for the US Stockmarket.

This indicator warned us of 3 major market peaks over the past 3 decades.

So it’s something we definitely need to factor in.

I will say two caveats though, first; you get the best signal on these types of indicators when it goes to an extreme AND then turns (i.e. see the circles below).

Second, it is just one data point and just one part of the larger puzzle.

But then again, we do have more and more puzzle pieces telling us similar things (be careful). For example, as covered in the Chart Of The Week (and featured + discussed regularly in the Weekly ChartStorm), consider the following points:

• Valuations are expensive and at cycle highs.

• Wall Street analyst expectations are euphoric.

• Investor allocations to stocks are at record highs.

Maybe we don’t peak immediately, maybe the market doesn’t crash, and maybe it just even goes sideways instead of down, and maybe it is all just different this time.

But maybe, just maybe, you should have a think about how to navigate your portfolio through a downturn. What if stocks stop going up? What if dips keep dipping? What if history repeats?

Do you have a plan to protect capital, do you have buffers in place, will you have cash to deploy on the other side of the downturn, do you have the fortitude to ride out a large or prolonged downturn in stocks, have you thought of ways to benefit in a downturn?

Sorry to give you extra homework, but definitely a few things to think about here!

Bottom line: the margin debt expansion indicator is at bear market warning levels.

p.s. yes —I will update this chart in future editions of The Weekly ChartStorm, so stay tuned!!

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Further Thoughts…

I wanted to add a couple of extra charts because I can just hear the questions already — first one is the same chart above but extended all the way back as far as the data goes. This one answers the queries around more data points, and basically it confirms the same message as the first chart. Yes it is a valid and reliable warning indicator.

The next chart looks at the year over year change in margin debt MINUS the year over year change in the S&P500, so basically it strips out the effect of market movements. Because I am sure some will quip that “yeah but margin debt just goes up when stocks go up, and stocks go up into market peaks”.

But again, the signal still looks good, and the surge in margin debt this year remains significant even adjusting for market movements. So again, the warning stands.

And as another angle, this chart shows the net margin debt balances (margin debt minus free credit) as a percentage of market cap, and this indicator just broke through the top end of the range. So basically another way of saying yes margin debt has gone up a lot and investors are more levered-up than usual. (again, yes the warning is still in place)

So while this is all just one data series, and only one of the many ways investors are getting levered exposure to stocks these days (with levered ETFs, futures, options, and various other “financial innovations”), and only one piece of the larger puzzle, it is a potent and clear warning signal.

It’s enough to make you want to dig further, and think a bit more about capital protection strategies and asset allocation so that you’re ready if/when it does turn.

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From a valuation perspective this market is divided into the Bigs (top 100) and the Big-Nots (everyone else).

If you’re big you attract all the flows, have a much lower cost of capital (aka very high valuations), you suck up a lot of small companies through M&A, and to be fair if you got big in the first place you probably have pretty decent earnings and growth.

If you’re small you’re off the radar, under-covered, under-valued, under-performing and probably underestimated.

And even if you’re large —but not the largest, you still trade at a discount to the largest companies.

As alluded, this is partly selection effects (successful companies get big), but also reinforced by the relentless rise of passive/index investing.

But where things are sitting now is what you would call extreme. And whenever you see an extreme in markets you want to pay attention because that’s where some of the biggest risks and opportunities can be found.

This chart highlights the risks on the one hand with mega caps as a group trading at the most expensive levels since the dot com bubble. Even if it is different this time (and it definitely is in many respects), this presents a very high bar and shows investor confidence is extremely high (investors expect the top 100 to continue to grow at an aggressive clip).

It also shows the opportunities on the other hand, with SMID caps trading at cheap valuations vs recent history and cheap relative valuations vs large and mega caps.

The interesting thing is we are starting to see early signs of a shift in relative performance — after lagging long behind, small caps are starting to play catch-up with the Russell 2000 making new all-time highs this week, while MAG-7 peaked in mid-May and are just treading water at the moment.

As discussed in the latest Weekly S&P500 ChartStorm, I reckon this could be the start of a bull market broadening and bullish rotation…

Bottom line: big stocks are trading on big valuations while smalls are trading at a big discount.

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Bonus Chart: aside from valuations, it’s also interesting to track market cap weightings. The below chart shows the market cap weight of the top 100, the S&P500 minus the top 100, the 400 (mid caps), and 600 (small) — as a percentage of the S&P1500 (which is the 500 + 400 + 600 indexes).

Key thing to note is that the biggest stocks are much bigger than usual …but ONLY the very biggest (top 100). The S&P 500 excluding the top 100 is actually at a record low market cap weighting. Meanwhile small and mid caps are likewise much smaller than usual. Again, let’s keep an eye on extremes like this as things unfold, because as interesting as life in markets has been these past few years, I think things can get interestinger still…

n.b. the blue lines are on the left axis, and the red lines on the right axis (so the top 100 are about 68% of market cap, and the small 600 about 2.5%).

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This week’s chart pretty much speaks for itself (+has just made a new all-time high).

To clarify, what we are looking at here is the estimated annualized compound growth rate expected by sell-side analysts over a three to five-year horizon aggregated for the S&P500.

i.e. consensus earnings growth expectations.

Or as I like to call it: Wall Street analyst sentiment.

And like all good sentiment indicators there are elements of truth and elements of emotion all mixed up in it.

In boom times euphoria takes hold and analysts raise their estimates as stock prices punch higher, new paradigm narratives take hold, and ultimately expectations end up overestimating even the best fundamentals.

In doom times pessimism reigns, and analysts slash their estimates as the economy stalls, stock prices plunge, and gloomy estimates dramatically undershoot even the worst downturns in earnings.

As things stand right now it is clearly in euphoria mode.

Some will argue that there is good reason for this, and as I noted they will be right that some of it is well-reasoned and true. But there is clearly a powerful sentiment and story dynamic that has swept up even the most sober analysts. And I would say that this is good example on both fronts.

Bottom line: consensus earnings growth estimates have reached an all-time high.

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Today’s chart is one for tomorrow’s history books.

It shows US households running the highest allocation to equities on record (and [as a result] the stockmarket trading at record high valuations).

This is the type of shift you see only once in a generation, and it means a fundamental change in market structure with significant implications for the economy, politics, and the forward looking risk vs return outlook.

But to be fair, with the S&P500 gaining more than 10x off the March 2009 lows — it’s an entirely understandable development!

And even though it got this way for very logical reasons (strong earnings growth, waves of tech disruption, low interest rates, passive flows), it’s important to acknowledge that this is not normal and we live in highly unusual times.

Investor confidence is near record highs, earnings optimism is at euphoric levels, defensives and diversifiers are in the dustbin, and social media chatter is saturated with an almost desperate sense of greed (with investors growing accustomed to 2x, 3x, 10x returns, and the bull market minting many geniuses).

This is the speculation generation.

p.s. this is neither good nor bad, it’s just a thing… and that’s the thing: as market analysts we ought to not got get bogged down in good or bad, bullish or bearish, optimism or pessimism —but rather what is the lay of the land? what does the data tell us? and what are the most pragmatic next steps we should take (or prepare to make…)

Bottom line: a generational shift in investor behavior has been observed.

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For most investors the KOSPI is not the first index they check when they get to the desk — they probably don’t even think about Korea…

But you should.

In today’s note I wanted to highlight a topic from my latest Weekly Macro Themes report from . Basically, Korean equities have gone parabolic.

(and yes, it’s AI again!)

And if you thought the US market was getting top-heavy and concentrated you haven’t seen Korea.

The top stock, SK Hynix, is tracking near-30% of the MSCI South Korea index. Close in second is Samsung Electronics at about 25% of the index. Add in SK Square and a few other stocks related to those two and the AI/chips theme, and you have over half the index tied up with the AI boom (/bubble?).

So what?

Aside from the wild upswing in stocks seen in the chart below, speculators have also bid-up Korean apartment prices, and the geopolitics-driven commodity spike is pushing up PPI inflation, and hence the Bank of Korea is set to get into rate hikes as inflation pressures rise.

The tail risk here is that the new BOK governor (his first meeting is tomorrow) decides to cast aside tradition and just get on with rate hikes (rather than first projecting next steps) when they meet on the 28th of May [Korea Time].

Polymarket has the odds of a rate hike at about 1% — so this is not something people are expecting, and in fairness is a very low likelihood.

But a hawkish surprise could rattle Korean stocks, and being that it’s basically a microcosm of the larger AI trade, it could easily ripple across to US tech stocks.

So it’s a bit of an under-the-radar risk and something to keep an eye on.

Bottom line: Korean stocks have gone vertical thanks to massive index concentration and the AI boom boosting Korean chip manufacturers (+a natural proclivity for speculation in South Korea).

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A key theme from the latest Weekly S&P500 ChartStorm was that the Stockmarket is currently in the process of “letting-off steam” following the sharp rebound-rally.

Valuations were one key example of “steam” building up…

Bigger picture, we are in a cyclically overheated market, the various valuation indicators say it’s expensive, and that does create a risk of rapid resets and eventual valuation mean reversion.

This is the risky end of the cycle.

And before you tell me about AI buildout and all the rest of the good reasons why stocks are going up, I understand that, and so does everyone else, and let me assure you — there is always a reason.

Bulls, Booms, and Bubbles start with good reason, and end when things get unreasonable.

So, on the topic of today’s chart, are valuations unreasonable yet?

Objectively speaking, the composite valuation indicator below is in the risky/expensive zone. It’s from around these levels that the market crashed in 1987, the dot com bubble peaked, and the 2021 stimulus frenzy fizzled out.

Those are 3 very different markets, and so yes it is different this time.

But the risk of downside echoes on.

From a pragmatic standpoint though, in the end, aside from freak crashes or crises, the thing that causes markets to go down in a sustained fashion (aka bear markets) is economic recession causing earnings declines and stressing weak spots (ultimately earnings are the key driver of stock prices in the bigger scheme of things).

In other words, markets downturns also start with good reason (a catalyst).

For now there are no signs of recession, there’s even some bright spots. But I’m keeping close tabs on the earnings pulse, macro leading indicators, and higher frequency cycle trackers, so I will be sure to update as/when/if the facts change…

Bottom line: valuation indicators are sounding a background warning tone.

p.s. yes —I will update this chart in future editions of The Weekly ChartStorm, so stay tuned!

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Conceptual Notes — Market Cycle

On of the core philosophies underpinning my research process is that macro and markets go in cycles, and that these cycles more or less rhyme across time, assets/markets, and geographies.

The conceptual model of the market cycle is displayed below — and this version is probably a bit more nuanced than what you might be used to seeing, because it recognizes the psychological turmoil, corporate/governance/peer pressures, and pitfalls that each stage of the cycle brings.

Within this framework we are close to that red dot on the valuation front.

But as they say, the trend is your friend until it bends…

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One more thing…

I’ll let the slide below do most of the talking, but basically, as alluded — there is nuance when taking theory into practice. And I would add, valuations are an important piece of the puzzle, but not the only piece (my approach = use many different puzzle pieces to find the true picture).

Also as a side note observation on the chart above, for those with a long-term perspective, even the most expensive markets always ended up higher in the longer arc of history (albeit those investors buying/adding on the lows vs peaks would have had a better time!)

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While most people are focused on AI stocks and Big Tech, this equal-weighted basket of space stocks* is up 17x off the low point in late-2022.

This reflects some major strides that several of these companies are making as the commercial space sector goes from dream to reality, but a key part of the more recent run-up is also down to anticipation of the SpaceX IPO.

My personal view is the commercial space sector and space economy will one day be much larger than even some of today’s biggest themes and sectors, and has a lot of growth ahead.

So I reckon this is something to pay more attention to if it’s not yet on your radar, and it’s probably still early days in this story…

Bottom line: space sector stocks have soared.

*RKLB, LUNR, RDW, VOYG, ASTS, PL, FLY, SPIR, BKSY, SATS

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Further Thoughts: ETF Market Share and the Future of the Space Sector…

While space sector stocks will almost certainly go through cycles of major boom and bust along the path (just look at the drawdowns in the chart above), I think that path is headed much higher in the longer arc of history.

There’s a few reasons for that.

While major progress has been made in the commercial space sector, it’s still early days. Only a handful of companies have a proven track record for launch services so far — and outside of launch, most companies are either focused on manufacturing and/or operating satellites (with much of the current use case being earth observation and telecommunications).

In the longer run it’s natural to expect this to expand to an array of orbital activities such as zero-gravity manufacturing, orbital space habitats for a variety of use cases (from tourism to media, science/R&D, defense) and logistics.

Further out (literally and figuratively) there will be science, tourism, resource extraction/processing/logistics and a host of things we can’t even imagine yet on the moon, near-earth asteroids, mars, and deep space. Particularly as we meet resource and environmental constraints on earth.

But even without that, the reality right now is that we are entering into a new space age where the big drop in cost to orbit is enabling new companies to do new things and open up whole new industries.

Coming back to earth, one interesting angle is that space focused ETFs (such as UFO, ARKX, NASA, ROKT, MARS) currently have a market share of about 0.04% — that compares to 0.32% for Aerospace & Defense ETFs (and a market cap weight for US Aerospace & Defense of just over 2%).

That means 2 things: 1. the average investor has very little exposure to this corner of the market, and 2. there’s a lot of room to move to the upside as the industry develops further and investors finally catch-on to what’s going on here.

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Capital Expenditure (aka capex) by tech and tech related companies now accounts for half of all S&P500 corporate capex.

Depending on your perspective, this is either the most bullish or bearish chart you’ve seen today!

The bulls will say this is a virtuous cycle of tech acceleration where more investment enables more breakthroughs, rapid rollout and scaling, which leads more revenues and favorable funding, which enables further investment (and so-on)

The bears will say this decadal-doubling is unsustainable and a classic bubble sign + late-cycle signal (there appear to be trends and cycles in this chart).

Meanwhile, economists might quip that it amounts to crowding out of investment that might have gone into industry, healthcare, and natural resources — which will come back to bite us later as flows funnel into AI and neglect real economy capacity building.

The pragmatic view is probably a bit of all of the above.

I would suggest this does look a bit overheated (and does represent a vulnerability), but also reflects the strong cyclical/thematic updrafts helping tech stocks drift higher for longer for now. It also helps explain why commodity prices are headed higher as commodity capex remains sluggish.

So it’s an important piece of the puzzle, and part of a very interesting theme I discussed in the latest Weekly S&P500 ChartStorm…

Bottom line: Tech capex has surged to 50% of all S&P 500 corporate capex.

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This week’s chart shows the market cap weighting of US semiconductor stocks (making record highs).

It’s a remarkable chart because at ~14% it’s basically double the level it peaked at during the height of the dot-com bubble.

It also comes at an interesting juncture as the SOX (Semiconductors Index) just chalked-up a record 17-days in a row of gains.

This is a dangerous market.

It’s dangerous for bulls because these are the types of conditions where you often encounter sharp corrections and crashes (even if it is the way of the future).

But it’s also dangerous for bears because this is basically the bubble-phase of the bull market — attempts at shorting could end up generating large losses in small time as a combination of greed, speculation, and fundamentals could drive semis even higher.

On that last point, students of market history know that booms, bulls, and bubbles start for a reason and end when things get unreasonable.

While bulls and bears often get taken by surprise in these types of markets, all my years in studying charts and observing market cycles tells me that there are always clues on the next steps for those willing to see.

And I’ll be bringing you more of these clues and views in the next Weekly ChartStorm, so stay tuned for more insights…

Bottom line: semiconductors are in the bubble phase of the bull market (which is dangerous for both bulls and bears alike!).

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This chart tracks what have been two of the biggest weak spots in markets.

(and is interesting for 2 key reasons)

First: both Bitcoin and Software stocks have stopped going down (and actually are starting to look very promising from a technical standpoint)

— i.e. the weak spots are no longer getting weaker.

That’s important because in markets weakness has a habit of spreading.

But also, further upside in these two (which is looking likely) will help rebuild sentiment and reinforce the bullish outlook for stocks in general.

Which brings me to the second point…

Second: both boast a bullish tactical outlook (as I just outlined in my latest Weekly Macro Themes report)

Basically, we’ve seen a major reset in price (software down more than -35%, bitcoin off almost -50%) and a big washout in sentiment/positioning.

And yet, the longer-term uptrend remains intact for both assets.

We’ve also seen both Bitcoin & Software stocks rebound off of clearly defined support levels (and p.s. those support levels also serve as useful triggers for risk management if the bull case doesn’t work out).

So it’s a very interesting chart from a market analysis standpoint, but also for the potential upside opportunities unfolding right now.

Bottom line: the weak spots are no longer getting weaker (and if anything, are actually starting to look bullish).

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This week’s chart is one for the bulls.

It shows the MSCI ACWI (All Countries World Index) aka Global Equities in the black line, and 50-day moving average breadth in the red (i.e. what percentage of countries are trading above their 50-day moving average).

Breadth indicators like this tell you a couple of things.

First, they give you an early heads up on global developments as the impact spreads across countries.

Second, for a shorter moving average timeframe like 50-days, it operates as an oscillator. In other words, it gives you overbought/oversold signals.

In traditional market analysis a true overbought signal is when an oscillator like this goes to an extreme high —and then rolls over.

That second part is key.

The reason is you can get an overbought market that stays overbought and gets even more overbought, so the turning point is what gives you confirmation that a change is underway.

Interestingly, we actually got exactly these conditions just prior to the March selloff (funny how events/news/catalysts tend to show up when a market is technically “ready”).

And then on the oversold side of things, we also have a textbook example unfolding right before our eyes.

A true oversold signal comes when an oscillator goes to an extreme low —and then turns up. That’s exactly what is happening in global equities right now.

To be clear, this is a very bullish short-term chart.

Now of course it is anyone’s guess as to what comes next, and geopolitics for example could cut either way (e.g. could get better [ceasefire] or worse [regional escalation] —albeit some might argue it can’t get much incrementally worse).

And yet, as I noted the other day, there are some bright spots in the global economy, and sometimes you just have to shut up and listen to what price is telling you …(especially when everything and everyone else is telling you all sorts of conflicting messages).

Bottom line: global equity technicals are short-term bullish.

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This week’s chart presents an unusual sentiment indicator which serves a specific purpose to a specific type of market participant.

This composite indicator takes into account sentiment readings from surveys + market metrics: the VIX (volatility/fear gauge) and the forward PE ratio (being ultimately a measure of investor confidence).

The inputs are also smoothed so that it provides the most useful signal to longer-term active investors who are less fixated on the day-to-day news/noise.

We’ve seen a significant reset in this indicator already.

This says we are close to a major market bottom.

However we still need to respect risk. The direction of travel (bearish momentum) from previously euphoric levels of sentiment does suggest caution, and the highest conviction bottoming signals historically came only once it reached or breached the zero-line (like it did in recent years during 2016, 2018, 2020, and 2022).

So it’s a key chart to have on the radar because even with today’s news (Trump comments on unilaterally finishing the War) and the enthusiastic rebound in stocks, it’s entirely possible that we still see another leg down before this episode is all done and over with given the various moving parts and lingering issues.

Bottom line: longer-term measures of investor sentiment have seen a major reset already (albeit are yet to approach levels seen around major market bottoms).

p.s. yes —I will update this chart in future editions of The Weekly ChartStorm, so stay tuned!

Conceptual Notes

Zooming out from the day-to-day developments, it’s useful to keep in mind the market cycle conceptual model.

The reason we want to respect risk in this type of juncture is that the stockmarket is stumbling and rolling over from expensive levels — this is the zone of maximum risk.

It’s entirely possible that we end up getting enough of a reset (in sentiment, valuations, positioning, and maybe even policy too) to engineer a short/sharp correction and resumption of the bull market… but given the background setup described and what we understand about market cycles, it would pay to be pragmatic about things (balancing the desire for maximum gains from participating in rebounds vs diversification and defense against the potential for further downside).

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Lastly, be sure to reach out at any time if I can help with anything. I promise to leave no questions unanswered and no problems unsolved.

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Best wishes,
Callum Thomas

Founder & Editor of The Weekly ChartStorm
and Head of Research at Topdown Charts

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LinkedIn: https://www.linkedin.com/in/callum-thomas-4990063/

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