Bank of America's clients are increasingly worried about a stock market peak. Here are 10 indicators to identify a top — and the best investing approach for when it unfolds. (2024)

In a note published Friday, the bank said that its clients have increasingly requested that its research team compile historical indicators of a bull market top. So that's what the bank did, listing 10 signals that they found to be most reliable, as well as the best investing approach for a market peak.

The good news: only 40% of the "signposts" are triggered today, compared to an average of 70% before prior market highs.

Are we there yet? 10 indicators to identify a market peak

The BofA team, led by Savita Subramanian, the bank's head of US equity and quantitative strategy, looked at indicators concerning sentiment and behavior, market valuations, and macroeconomic factors.

So far, the four indicators that have been triggered include consumer confidence levels, investor confidence levels, an inverted Treasury yield curve, and tightening credit conditions.

The three overarching categories and their respective indicators are listed below.

Investor Sentiment and Behavior

Investor sentiment and behavior indicators monitor how both consumers and Wall Street feel about the market and economy.

Elevated readings on The Conference Board's Consumer Confidence measure are a consistent indicator of a bull market end that has been triggered this year. The index has reached 110 within the six months preceding every market peak since July 1990, and in January 2024, it reached 111.

Investor confidence, which Bank of America quantifies as the net percentage of consumers expecting higher stock prices over the next 12 months, according to data from The Conference Board, is another indicator of a market peak. Prior market peaks have seen net bullishness of over 20%. Net bullishness is 23% right now, triggering the indicator.

High sell-side strategist equity allocations, which Bank of America tracks with its Sell Side Indicator (SSI), have preceded three of the last six bear markets but aren't present in today's market. The SSI takes the average of Wall Street analysts' stock allocation recommendations, providing a "Sell" signal when Wall Street is bearish and "Buy" when Wall Street is bullish. At the moment, the SSI is "Neutral."

When Wall Street has high expectations, stocks are more likely to disappoint, which is why long-term growth expectations for S&P 500 companies are another indicator of a market peak. Four out of the last six market peaks have seen S&P long-term growth expectations over one standard deviation above the five-year average, but the indicator is untriggered, as expectations remain relatively tempered.

The dot-com bubble, 2008 financial crisis, and 2022 bear market all experienced elevated M&A activity immediately prior, making deal activity a telling indicator of a market peak. Often, high deal volume, which Bank of America quantifies as trailing three-month deal activity greater than 1 standard deviation above the 10-year average, may signal high investor confidence and interest in growth opportunities. Such is not the case today, as M&A activity has declined coming out of 2022 and has remained low.

Valuation

Elevated stock valuations are also telling of a market peak, but Bank of America's indicators relating to P/E ratios aren't currently triggered.

Historically, a high P/E ratio and inflation have marked the end of a bull market, as the S&P 500 usually declines after the sum of both the index's trailing P/E and year-over-year CPI is at least one standard deviation above the 10-year average sum. The trailing P/E of the S&P 500 right now is 24 and CPI is 3.3%, making a sum of 27. That's 0.9 standard deviations above average, not quite high enough to indicate a market peak.

Oftentimes, expensive stocks outperform cheaper stocks right before a market peak, with high forward P/E stocks leading low forward P/E stocks by at least 2.5% in the six months before a top. Although growth stocks are currently performing well, this indicator is not present in the market.

Two macroeconomic indicators, the inverted yield curve and tightening credit conditions, are triggered in today's market. The yield curve has been inverted since July 2022, traditionally a signal investors are worried about the health of the economy. And according to the Fed's Senior Loan Officer Opinion Survey, banks tend to tighten commercial and industrial lending standards to large firms right before market peaks. Right now, 16% of banks have tightened credit conditions, meeting the threshold for prior market peaks.

A third macroeconomic indicator, Bank of America's Credit Stress Indicator (CSI), is not triggered. The CSI measures credit conditions using elements such as volatility, credit access, leverage, credit ratings, among others. It often drops below 0.25 within six months of a market peak, but sits at 0.39.

How to invest at the top

With all of these mixed signals, it can be difficult to make investing decisions in today's market. What should investors do once the market peaks?

According to Bank of America, the best investment approach is also the simplest one: hold.

Holding onto investments is better than selling out of panic or fear, the bank said. Historically, cumulative returns before and after market peaks even out around the six-month mark and lean positive by the 12-month mark, meaning that longer holding durations can reduce the likelihood of a loss.

For the S&P 500, the longer the holding period, the less likely it is for negative returns: There's a 46% probability of loss for a one-day period, but only a 5% probability of loss for a 10-year period, the bank said.