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Friday, March 29, 2024

A Different Look at Market Tops

Courtesy of Doug Short.

Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.


Last week the S&P pushed through to a new all-time high, recovering from a pretty minor 3.94% pullback into early August. In fact, it’s pretty remarkable that each pullback has been shallower than the last going back several years.

You may have read commentary to the effect that the lack of any serious pullback means we are in the early stages of a new secular bull market. Some of the more bullish writers have gone as far as to predict that we won’t see a correction as large as 7% for at least the next several years — well into 2017. Whether it’s the plodding nature of the recovery, the Fed, the lack of good alternative investments, or valuations that have a ways to go to hit historic extremes, it doesn’t really matter. Something is different this time.

Others look at the same market and come to the opposite conclusion with some even suggesting a high likelihood of a market crash.

Human nature means that we tend to remember best our recent experiences. Does the current market look very similar to how it looked in the year leading into the market peak in 2000 or 2007? Doesn’t the last year of a bull market look much more like a tug of war between the bulls and the bears? As if neither side was too sure of itself? Certainly, the current market doesn’t look antsy about much of anything. Shouldn’t it look at least a bit antsy if we’re nearing a top? And just how do you measure ‘antsy’? The VIX is one way, but you can only track the VIX back so far in time. It was also fairly low in 1987, so it wasn’t telling us much then.

One possible way to look at ‘antsy’ would be to simply chart the percentage changes from day to day. If traders are antsy about something, that might show up as higher daily percentage swings. The chart pair below is the day to day percentage fluctuation in the Dow Industrial’s price for the year preceding the market top in 2000. The second chart of the pair is the last year of the current market.

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Note: Click any chart pair for a larger version

Both charts are the daily percentage changes in the Dow for one year. In 2000, the Dow peaked in January, so we’re looking at the daily fluctuations mainly in 1999. Pretty clearly the current market does not look nearly as antsy as it did in 1999.

The next chart pair is the year prior to the peak in 2007 versus our current market.

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Again you see much more day to day variability in 2007, particularly in those last few months.

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And above is what 1987 looked like versus today. To keep the scale the same, the 1987 chart cuts off a few spikes in daily price moves above 3% and below -4%, but not many.

Hmmm. Maybe we’re on to something here.

Going back nearly 100 years, there was an important market peak in 1919, prior to a bear market low in 1921. Really antsy here!

Click to View

Again, to keep the scale the same, the 1919 chart cuts off quite a few spikes where the market gained more than 3% daily or lost more than 4%.

Looks like we’re pretty safe, doesn’t it?

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Uh, oh! The year preceding the bear market low of 1962 wasn’t as volatile as the current market. Of course, the loss into 1962 was only 27%. Perhaps the 1961 chart is the exception that proves the rule. Maybe there aren’t any others.

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Oops, there are — but again a fairly timid bear as those things go.

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Uh, oh! The 1968 chart again looks less volatile than the current chart — but that led to a 36% bear market loss into a low in 1970. But wait, didn’t the oil embargo cause that loss?

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Nope! That began in October of 1973 (and well after the top), but helped the Dow to a 45% decline. Again we see less daily volatility heading into that market peak; nothing to be antsy about here!

Some Conclusions on Volatility (or Lack Thereof) at Market Tops

My point in showing the day by day volatility preceding eight important market peaks wasn’t meant to prove anything, but it was meant to disprove the idea that we can’t be near an important market top because there isn’t much day to day volatility. There certainly are times when it seems like traders know something is coming. The mother of volatility preceding a bear market was, as you might have guessed, the year preceding the market top in 1929.

Click to View

Using the same scale on both charts, 1929 saw numerous spikes way off the chart both directions. In hindsight, doesn’t it look like they might have seen that one coming?

I hope the preceding charts show you that traders may have seen 1929 (and some other topping years) as reasons to get antsy, but also that they sure don’t always see something coming. We do seem to judge things by what we remember from recent history. But looking at a bit more history may put things in better perspective … and perhaps it really isn’t that much ‘different this time’.

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