A top portfolio manager at a $9.6 billion firm shares the 2 indicators that tell him

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David Wright of Sierra Investment Management is warning that stocks may have peaked.
He said various indicators are showing indexes are at or near a top.
He said the Dow Jones Industrial Average would fall 50% over multiple quarters.

Following the Dow Jones Industrial Average‘s blistering 89% rise from its March 2020 lows, the index is starting to see some

volatility

. Since November 8, it’s dropped as much as 6.6%.

The recent change in direction has investors wondering: have stocks peaked?

According to David Wright, the cofounder and co-portfolio manager of Sierra Investment Management, which manages $9.6 billion in assets, there’s a 50/50 chance stocks have started their descent into

bear market

territory. And if they haven’t peaked yet, they likely will in the coming months, Wright said.

“We’re at a period of very high risk,” Wright told Insider on Thursday. “Time to buckle your seatbelts.”

The downturn Wright is calling for isn’t just any bear market. Wright believes the Dow is due for a 50% drop, and the Nasdaq a 70% fall, given how inflated market valuations have become amid unprecedented fiscal and monetary stimulus. He said the drop would occur over multiple quarters.

But why now? Wright said he’s become bearish because he’s seeing indications of internal weakness in the market.

One of them is poor breadth. On Thursday, for example, 124 stocks on the New York Stock Exchange posted new 52-week lows. Only 10 posted new 52-week highs.

“What this means is that only a few large stocks are holding the indexes up, while an increasing number of stocks are already in bear markets,” Wright said. “This divergence is often seen in connection with major market highs, and was a key signal in the weeks before the crash of 1987.”

Another indicator Wright pointed to was extreme bullishness. He said investor complacency is as high as he’s ever seen it. He cited the very low ratio of put options to call options as an example of this.

“There’s a complacency factor in this market that I don’t think we’ve seen in a hundred years,” Wright said. “We’ve seen in the US a 12-year very strong market, rising market, with only very brief and very limited setbacks. This has resulted in a cultural shift toward massive risk-taking.”

As for what could trigger the market crash, Wright cited a number of potential threats including the Omicron variant of COVID-19.

The biggest threat, however is the high rate of inflation. The Consumer Price Index, a main measure of inflation, is up more than 6% year-over-year, the most in more than 30 years.

With the

Federal Reserve

getting set to taper its asset purchases, which are currently pinning Treasury bond yields down, persistent inflation could pull interest rates up in a meaningful way, drawing people away from stocks.

Inflation, paired with the Omicron outbreak, could also disrupt the economic recovery and sink investors’ expectations of growth.

Wright said that if stocks end two out of three months negative, he will view it as confirmation of a peak. The S&P 500 closed down 1% in November.

The bigger picture

Many on Wall Street seem to be in agreement with Wright’s call that stock indexes have peaked or are near their peak.

Bank of America’s Chief US Equity Strategist Savita Subramanian said in November that she expected stocks to drop 20% by November 2022. Many 2022 S&P 500 price targets are also lower than the index’s current level of 4,538.

The bearish investor John Hussman also said in late November that a “motherlode” of internal market indicators were signaling a peak, prompting him to write an unscheduled note to investors.

Investors seem to be increasingly worried about the economy. Federal Reserve Chair Jay Powell said this week that it’s time to retire the word “transitory” when it comes to inflation. The first Omicron case in the US was discovered, and Friday brought a lackluster jobs report as the US added just 210,000 jobs in November. Economists had expected 550,000.

If the economy begins to sputter in a serious way, it could be a nightmare for investors amid very high growth expectations. Subramanian and others like Stifel’s Barry Bannister are warning that forward growth expectations are already too high.

But there are positives in the economic story as well. Consumer spending remains abundantly strong, and unemployment is falling back toward pre-pandemic lows.

It’s difficult to call market tops. Stocks could continue their volatility, rising and falling and effectively going nowhere over the months ahead. But if Wright is correct, the exact top will be difficult to spot, and may be apparent only months later.