Warning Signs for the S&P 500: Indicators Flashing Red

The article discusses three key indicators flashing warning signals for the S&P 500. These indicators, which mimic the herd mentality, invite regression to the mean. The article warns of potential market downturns and advises against following the herd, citing Charlie Munger's quote. The warning signs are based on the article's analysis of market trends and indicators.

The S&P 500 has been on a remarkable rally, setting new all-time highs [1]. However, recent market trends and indicators suggest that investors should be cautious. Three key warning signals are flashing, mimicking the herd mentality and inviting regression to the mean, as Charlie Munger famously advised [3].

Firstly, Goldman Sachs analysts have noted a sharp rise in their Speculative Trading Indicator [1]. This gauge, which measures the share of trading volumes in unprofitable stocks, penny stocks, and those with rich valuations, has reached its highest level since the dot-com bubble era, excluding the COVID-19 period. The indicator shows an elevated recent share of trading volumes in speculative stocks like BigBear.ai (BBAI), Lucid (LCID), and Plug Power (PLUG). While similar spikes in speculative trading have led to stronger-than-usual returns over the next three to six months, they often falter over a two-year horizon.

Secondly, the Cboe Volatility Index (VIX), a measure of market volatility, has been relatively low but has shown pockets of volatility in recent weeks [2]. This index, often referred to as the "fear gauge," spiked to 60 in April but has been below its long-term median of 17.6 for most of July. However, the recent highfliers in the meme-stock rally, such as Krispy Kreme (DNUT), Opendoor (OPEN), and Kohl's (KSS), have been heavily shorted, indicating potential over-exuberance among retail investors.

Lastly, the S&P 500 has reached historically expensive valuations, trading at 22.6 times earnings estimates, well above its long-term average P/E ratio of 15.8 [2]. This valuation level makes the market vulnerable to disappointments, especially with earnings reports from megacap companies like Apple, Microsoft, and Amazon looming in the near future.

Investors are advised to exercise caution and avoid following the herd mentality, as history shows that such behavior often leads to market downturns. While the current market conditions present opportunities, it is crucial to stay vigilant and consider the warning signals flashing across the indicators.

References:
[1] https://finance.yahoo.com/news/speculative-frenzy-raises-risk-of-stock-market-downturn-goldman-sachs-170158384.html
[2] https://economictimes.indiatimes.com/news/international/us/us-stock-market-outlook-sp-500-nasdaq-to-plunge-into-volatility-from-all-time-highs-check-wall-street-signs-before-august-1-tariff-deadline/articleshow/122936695.cms
[3] https://seekingalpha.com/article/4805012-sp500-three-key-indicators-flashing-strong-warning-signals