The stock market has run out of fuel. The fuel I’m speaking about is growing earnings, rising valuations, skeptical investors (becoming more bullish) and macro tailwinds. These are the things that are required to push prices higher and they’re in very short supply right now.

preannouncementsPrior to the end of the second quarter we saw the worst pre-announcement season on record. Now that companies have begun to announce actual numbers we find that earnings growth for non-financial companies is coming in at a -3% rate year-over-year. This is one major reason economists have been reducing their expectations for second quarter GDP growth to near zero. This is one tailwind for stocks that looks to be in the process of turning into a headwind.

If stocks were cheap this might not matter so much. But stocks have recently reached valuations that have historically marked major price peaks. According to Doug Short’s four valuation metrics stocks are anywhere from 39% to 77% overvalued at current levels so it’s hard to imagine rising valuations driving prices even higher from here.

Turning to sentiment, retail investors have recently become “extremely bullish” on stocks. And they’re putting their money where their mouths are: they recently poured more money into the stock market than any other time since the financial crisis. Typically, these times of extreme sentiment are very good contrarian indicators and the “smart money” is taking it as just that sort of signal.

Finally, the Fed, after years of historic accommodation, has recently begun planning its “quantitative easing’s” end game. It doesn’t take a genius to see how this program has affected the asset markets over the past few years. Both stocks and bonds have done very well during the implementation and increase of QE. The fact that the Fed says they are nearly ready to end the program removes a major structural support for both asset classes even if it is more psychological than literal.

Koan: If the mere talk of reducing “quantitative easing” causes a record increase in interest rates, what happens when the Fed actually ends the program?

spxStill, stock market tops are more of a process than a single event. This is why the saying, “they don’t ring a bell at the top,” has been around so long. By the time most people realize a top has been put in stocks have already declined dramatically. In real time, it’s very difficult to see to all but those who are paying very close attention to the warning signs.

The warning signs are always there and right now there are plenty. In fact, I would go so far as to say the only thing keeping prices aloft right now is momentum and euphoria. Momentum has now begun to wane (see the stochastic divergence setting up in the chart to the left) and after the real estate bubble everyone should be familiar with the consequences of euphoria. The real fuel has been spent and these fumes can only can only last so long.