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Five reasons the market must fall

March 20, 2014, 2:56 PM UTC
Illustration: Brock Davis

There’s a name for what you’re feeling. It’s called barophobia — the fear of gravity. The bull market in U.S. stocks celebrated its fifth birthday in early March. And each time the indexes reach a new milestone — the S&P 500 closed at a record high of 1,878 on March 7, even as the Nasdaq was reaching its loftiest level in 14 years — the anxiety grows a little greater. Don’t stocks have to fall back to earth soon? Aren’t shares expensive? Just how long can the markets fend off Fed tapering, polar vortexes, and Cold War-style tension with Russia before a major selloff becomes inevitable?

To answer those questions, we consulted veteran market observers and dug deep into the numbers. The conclusion? It makes sense to be a barophobe right now. (And, yes, it’s pronounced “bear”-o-phobe.) Here are five reasons to believe that shares will soon retreat — and one good argument for why the bull might keep running.

Reason No. 1: Beware the aging bull

Since World War II, the average bull market has lasted 4½ years, and this one just turned five. Only three of the previous 11 bull runs made it to their sixth birthday, according to Sam Stovall, S&P Capital IQ’s chief equity strategist. Moreover, the average bull has produced a gain of 141% for the S&P 500, and the current bull has already returned 173% through February. “The laws of investment gravity will take hold at some point,” says John Linehan, head of U.S. equities for T. Rowe Price. Linehan thinks we may be due for a 10% to 15% correction. Says Michael Cuggino, president of Permanent Portfolio Family of Funds: “The key thing is, What do you do from here? Are the next five years — or is even the next year — going to be anywhere as good as the previous five?” Worth noting: Bulls that did reach a sixth anniversary averaged a 26% gain in the 12 months after turning five.

Reason No. 2: Prices are way ahead of earnings

The S&P 500 currently trades at around 16 times estimated year-ahead earnings, a multiple that has increased by 50% since 2011 — the largest P/E expansion since the late 1990s. “The question becomes, Is it 1996 or 1999?” says Russ Koesterich, BlackRock’s global chief investment strategist. He leans toward the former, believing that earnings have more room to grow. Others see the huge multiple expansion as a reason to tap on the brakes. “It could be a sign that we’ve come too far too fast,” says Sam Stewart, founder and chairman of Wasatch Advisors, the $19 billion mutual fund company in Salt Lake City. (For more on stock prices, see John Cassidy’s column.) One telling stat: Morningstar can find only 12 stocks in its coverage universe worthy of its five-star fair valuation rating now, compared with more than 850 during the depths of the financial crisis.

Reason No. 3: A stubbornly sluggish economy

Economic growth appears to be going in the wrong direction. The Goldman Sachs Global Leading Indicator Index, comprising various manufacturing and trade measures, is in slowdown phase, with eight of 10 components sinking in February. And Citi’s U.S. Economic Surprise Index, which illustrates how data compare with expectations, plummeted from 73 in January to -36 in mid-March. Investors have largely written off the winter’s economic freeze as a temporary effect of the frosty weather. But if the economic data don’t blossom come spring, the market could be in for a shock.

Reason No. 4: Fewer stocks are reaching new highs

The indexes may still be marching up, but a decreasing number of stocks traded on the New York Stock Exchange are setting new 52-week highs — less than 19% in early March, vs. 28% last May. That kind of erosion happens in an aging bull market roughly a year before it dies, says Paul Desmond, president of Lowry Research. He compares it to the way leaves in autumn “start turning and fall off.” At the very end of bull markets, he says, the new-high rate gets down to 6% on average. By then, the tree is barren.

Reason No. 5: Too many people think it’s a good time to buy

As Warren Buffett says, the time to be fearful is when others are greedy. And optimism appears to be growing. The weekly Advisors Sentiment report, a half-century-old survey of 120 advisers put out by Investors Intelligence, declared in mid-March that bullishness hit 55% — considered to be the threshold of the danger zone. Doug Kass, the manager of hedge fund Seabreeze Partners Management and a noted bear, says many of his fellow short-sellers have stopped betting on the market to fall: “There are just no shorts left standing.”

Now that you’re depressed, here’s one big reason the bull might not be over after all: because we’re saying it could be. “Markets go down when the last dumb buyer has bought,” says Tom DeMark, the CEO of DeMark Analytics and a market-timing specialist, who is himself turning bearish. As long as there’s a healthy dose of skepticism, the possibility for new highs remains. That’s why it’s a good sign that the CBOE Volatility, or “fear,” index has risen recently.

What should you do? If you’re an average investor, not much. Stick with the basics: Keep a diversified portfolio of low-fee funds and put money in at regular intervals. Trying to time the market is too difficult. But this might not be a great moment to speculate either. Thinking about buying a hot stock like, say, Tesla? Stewart of Wasatch suggests this reality check: Mark it down by 20%. “Would you still like it?” he says. In other words, get ready for gravity.

This story is from the April 7, 2014 issue of Fortune.