As Mark Twain famously said, even if history doesn’t repeat itself, it often rhymes. Admittedly, no two market tops are exactly alike, but they all have several elements in common.
So, how do you spot impending market tops before they occur?
To answer this question, our research team has conducted an analysis of economic conditions present at each significant US market top over the past 100 years, looking at only those declines where the peak to trough magnitude was 40% or greater. In particular, we studied:
- The crash of 1929 and 1937, which coincided with the great depression era.
- The two major bear markets of the 1970’s, which coincided with the stagflation era of most Western nations.
- The 1987 black Monday/Tuesday stock market crash.
- The New Economy / Tech Wreck crash beginning in 2000.
- The 2007 to 2009 Global Financial Crisis.
While the circumstances which led to each crash were unique, there were undoubtedly several economic signs that were consistently present at or just before each market top.
Here’s what we found them to be:
- A strong or strengthening global and local economy – You can’t have a big bust without first having the big boom.
- A sustained period of monetary tightening – Because of the strong growth, central banks will tend to tighten monetary conditions until they break something in the economy.
- Significant stock market overvaluation – For prices to fall significantly, they first have to rise significantly.
- Investor euphoria – As Warren Buffett is famous for saying, “Be fearful when people are greedy. Be greedy when people are fearful.” Many sentiment surveys often show their strongest readings just before the peak.
- Interest rate spreads – Investors become concerned about the “Return OF Capital” rather than their “Return ON Capital”. As such, the difference in interest rates between low risk and high risk borrowers widens.
What’s more, having only two or three of these conditions is not enough. You almost always have to see ALL FIVE being present before a market top establishes itself.
Over the course of our next five (5) articles, we will explore each of these market conditions in more detail in a bid to better prepare you for what could be a much riskier investment environment to come.
If you want to learn how to invest in stocks and analyse the market to identify profitable or deadly turning points, contact United Global Capital today for a no cost, no obligation consultation on 03 8657 7640 or email [email protected] to learn about Quality, Value, Trend (QVT) investment selection methodology.
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The information contained in this article is General in nature and has been prepared without taking into account your objectives, financial situation and needs. When assessing any investment you should also consider that past performance is not a reliable indicator of future performance.