Economists and government officials have a horrible track record of forecasting financial crises. But, despite their strong inclination to bury their collective heads in the sand, we are now witnessing a massive market bubble that may cause one of the worst downturns in history.

It’s understandable why they consciously choose to ignore the obvious. While bubbles are expanding, they benefit almost everyone. So of course those economists and government officials don’t want to be the naysayers who rain on everyone else’s parade. Instead, they ensure the populace that everything is fine and that this time it’s different.

While they’re grossly mistaken about the first part, they are 100% correct about the second part. This time is definitely different. But it’s different for all the wrong reasons… about four trillion Fed-driven reasons.

Over the last five years, the Fed has been busy pumping trillions of dollars into the economy through a variety of quantitative easing (QE) programs, all in an effort to keep the current stock bubble going. Although the latest QE program is winding down, the Fed continues to goose the economy with super-low long-term interest rates that have been in place since 2008.

So that’s why this market bubble is so different from its predecessors. Never before in history have world governments worked so hard to keep one going, but in the end it’ll all be for naught and only make things worse.

This bubble, like all other bubbles in history, will eventually pop.

The good news is that the next market collapse is something we can prepare for, and there are at least seven warning signs to help us do so.

Here’s What to Watch

Here are the key signals to watch for as the next market peak approaches.

  • Margin Debt — Now well past the 2007 high of $430 billion and rising fast, these readings have climbed higher during each market peak. Currently north of $470 billion, this one could top out as high as $500 billion.
  • Stock Buybacks — Taking advantage of record-low interest rates, 85% of S&P 500 companies are currently buying back their own shares. In 2007, it was 87%.
  • Corporate Profit as a Percentage of GDP — Also driven by record-low short-term interest rates, the current level of 11% is already the highest ever. It exceeds even the extreme 2000 bubble and the 1950 level of 10%.
  • P/E Ratios — Most major stock peaks occur between a P/E ratio of 22 and 27, when adjusted for cyclical patterns. Currently, we’re above 26 and moving higher. So the best assumption would be that this bubble will peak at the same cyclically adjusted P/E level seen in 2007, or around 27. (Don’t listen to analysts that quote normal P/E ratios, because they are too volatile. This cyclically adjusted measure takes the inflation-adjusted average earnings over the last 10 years, not current earnings.)
  • Market Value of Non-Financial Stocks Divided by GDP — During major peaks, the ratio of market value of non-financial stocks divided by GDP tends to range between 0.3 and 1.5. It’s now at 1.3 and rising, likely heading toward 1.4.
  • S&P Price-to-Revenue Valuation — The S&P price-to-revenue valuation model is already flashing warning signs as it approaches the highs of 2,000. The current level would suggest a long-term range of negative 3% per year at worst, to 1% at best. This is similar to what investors saw after the 1929 peak.
  • Bulls vs. Bears — Bullish investment advisers have recently represented 62% of the market, whereas bearish advisers are at 14%. Prior to the last peak, levels were 60% to 62% bulls and 18% to 20% bears, so the current readings suggest the market could turn at any time.

A Note About Indicators

Unlike previous bubbles, the pattern of this one is very difficult to predict. Years of thorough market manipulation by the Fed and central banks have affected the accuracy of most traditional major indicators. For example, leading indicators which prior to 2008 could provide a six- to nine-month warning now give two months at most, if any.

However, based on exacting research, the signals listed above should provide the surest indication of a peak before the pop. Granted, that warning will not be as far in advance of the market peak as previous ones were, but even two months could make all the difference. To learn more about how the next market collapse will unfold and how you can sidestep the carnage, please click here.

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Chris Cimorelli
As the managing editor for Economy & Markets, Chris works directly with Harry Dent, Rodney Johnson, and the rest of the Dent Research team to bring you their economic analysis and market insight six days a week. Prior to working for Dent Research, Chris was an English teacher in Baltimore City.