Being able to accurately spot the beginning of a bull market can be one of the most lucrative skills around. This fact alone makes it difficult to achieve, as so many well-educated and experienced investors try to spot the signposts that lead us into traditional bull markets.
Are we in one right now? Opinions vary, but the S&P 500's 45% + rise since March 2009 certainly meets the traditional definition of a 20% rise from a market low. But a better definition of a bull market is an extended period of time when markets are stable with an upward trend. The extended part is key, as it allows all investors the chance to participate without feeling like it's a race to the top.
Let's look at five signs that tend to predict the next bull market. No single one is a surefire tip, but that's just the way Mr. Market likes it: he has a nasty habit of eliminating patterns and keeping investors mystified for as long as possible.
Sign No.1 – Sector and industry leadership changes in the stock market.
In the most basic sense, bull markets come when more people want to buy stocks than sell them.
Because stocks love to turn bullish before the broad economy picks up, look for a shift in demand to the stocks that benefit first from economic growth. Stocks in sectors like financials, industrials and retail often lag behind in a bear market - nobody wants them.
When a bull is approaching, these sectors often become market leaders. Large institutional investors start piling in, hoping to see the conditions of these companies improve first. So look for leadership to change from defensive sectors like utilities, healthcare and consumer staples. When investors start dumping the latter in exchange for financials, industrials and basic materials, it's a good sign that major investors are optimistic about the future. (To learn more, read Industries That Thrive On Recession.)
Sign No.2 - Key economic indicators turn upward.
We get a slew of economic indicators all throughout the year, but several have been deemed leading indicators for their ability to foretell future growth in the all-important indicator of gross domestic product (GDP).
When GDP is positive and growing, the bull market is already in. So look for a turn in the following key leading indicators:
A true bull market should be predicated by all four indicators showing growth, or at least changing direction if they have been falling for several months.
Sign No.3 - The Baltic Dry Index turns sharply upward.
The Baltic Dry Index is a specialized measure of the rates paid by producers and shippers of key raw inputs like coal, iron ore and grains. These raw materials are purchased by the ton, so they need to be put in large carrier ships and sent all around the world to the companies that will use them to create energy, steel, food products and other consumer goods.
This index is good to watch because there's a long lead time before growth in shipping leads to higher production of goods by the end users themselves. The Baltic Dry Index is also quite volatile, so higher price action is easy to spot, and may give a clue toward future growth in the economy long before it shows up elsewhere.
Sign No.4 - Money market fund assets drop.
When investors are generally skittish, they sell their risky investments (stocks) and move cash into safer ones like bonds and money market funds.
In a bear market, money market fund assets will rise and rise, building a bubble of pent-up demand. After all, money market funds may be safe, but they won't earn you a solid return. (For more insight, see Do Money Market Funds Pay?)
The Investment Company Institute publishes weekly figures on the aggregate amount held in all types of funds - stock funds, bond funds and cash funds. Look for a sustained drop in money market fund assets, and a corresponding rise in stock fund assets. This will signal that investors are making their way back into the stock market. The higher that money market assets grow in a bear market, the more gunpowder is available to fire back into the stock market when the bull is back.
Sign No.5 - Stock indexes stabilize.
This last sign may sound overly redundant, but don't be fooled by its simplicity. Stock market indexes need to form a bottom that can be recognized by all participants. They then need to form a stable upward trend over weeks and months, rather than a volatile zig-zag that threatens to turn south just as much as north.
The more stable the trend of the broad indexes - like the S&P 500 - the more confident investors can become, especially those who have been patiently waiting on the sidelines for obvious signs of safety before dipping their toes back in.
Don't be afraid of missing a few percentage points of stock returns in your efforts to safely and accurately spot a bull market. The best bull markets last for years, not months, and you'll sleep far better at night if you've developed strong convictions about your investment. Leave the whipsaw trading to the iron stomachs of the world, and take your time in evaluating all the signs.