One of the best signals in the stock market may be saying it’s time to sell

Red warning lights signal siren
Watch out! Wikimedia Commons

It’s impossible to know the exact time to buy and sell stocks.

As we’ve noted before, timing the market is notoriously hard and generally leads to investors missing out on big gains.

However in February, John Stoltzfus of Oppenheimer highlighted what may be the best signal for timing the market: the trailing 12-month price-to-earnings multiple.

At that time, Stoltzfus said that the P/E looked very cheap and was nearing a point where it has rallied numerous times over the past few years. Now, it looks as if the market is nearing the top based on the same indicator.

“At 18.83x, Friday’s trailing 12-month P/E multiple stood at around a 13.7% premium to the market’s long-term average trailing 12-month multiple of 16.54x, and the market (as illustrated by the performance of the S&P 500) has shown resistance to pushing through a level of 19x since February of 2014,” wrote Stoltzfus in a note to clients Monday.

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Now there are a number of fact that could make stocks cheaper, the most obvious being a drop in price, but also an increase in profits. Additionally, it could be that stocks just remain on a higher trend against the long-term average. Stoltzfus points to Treasury yields as an example.

“That said, the average yield on the 10-year Treasury note since the end of 1965 through last Friday stands at 6.54% versus a current yield on the 10-year of around 1.77%,” he said.

While this is an imprecise measure, as Stoltzfus himself admitted, prior trends can help to inform not only the future but also investors thinking.

“While economic, revenue and earnings growth are principal factors that move stocks higher, the relative value of asset classes and their respective prospects for better returns can serve as near-term factors determining which asset classes are favoured by investors,” wrote Stoltzfus.

Put another way, if investors think stocks are too rich they will start to sell them in favour of other types of assets dropping the P/E back towards the historical average.

Investors will just have to keep an eye on the measure going forward, or as Stoltzfus concludes, “Stay tuned.”

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