We all know bull markets go through a process when topping. It is always easy to distinguish after the fact but while it is happen people seem to go into denial. Take a read and see if you agree.
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Based on historic patterns, bull markets die in three stages, and investors familiar with the anatomy of a dying bull market rarely get stuck with the hot potato (losing stocks). Investors must realize that bull-market tops are a process, not an event. Tops are carved out over time.
The following piece of “Seinfeld” wisdom (originally applied to relationship breakups) also applies to the stock market: Market tops are like knocking over a Coke machine. You can’t do it in one push. You gotta rock it back and forth a few times, and then it goes over.
Typically, the major headline-grabbing large-cap indexes — like the S&P 500 and Dow Jones — are the last ones to peak. The average stock peaks long before the large-cap indexes.
Fun fact of the day: By the time the Dow Jones Industrial Average made its final 1929, 1961, 1973, 1981, 1990, 2000 and 2007 bull market highs, 25%- 55% of all NYSE stocks were already down more than 20%. It’s incredible that 25%-55% of the stock market universe was already in a bear market at the same time the DJIA peaked.
The May 31, 2015, Profit Radar Report warned of similar internal deterioration:
“At the latest all-time closing high for the S&P 500 (2,130.82 on May 21), 13% of S&P 500 stocks already lost 20% or more since their latest high. 17% of S&P MidCap 400 stocks already lost more than 20%. 23 % of S&P Small cap 600 stocks already lost 20% or more. Negative divergences like this tend to draw stocks lower. This doesn’t have to happen immediately, but this particular divergence has lasted longer than any other in the last years, and is likely to turn into a drag eventually.”
This kind of internal deterioration is rarely reported, but it’s for real, and painful for investors with portfolios of individual stocks (especially if it’s not an all large cap portfolio).
Being familiar with the three stages of a dying bull market helps investors to gauge how far away the bull is from the butcher.
3 Stages of a dying bull market
First stage
Psychological process: Finding value becomes a challenge and investors become pickier.
Technical manifestation: The number of stocks hitting new 52-week highs or the percentage of stocks above the 50-day simiple moving average (SMA) slides lower while prices climb higher.
As the chart below shows, the percentage of stocks above their 50-day SMA did not confirm the May highs. In fact, the percentage of stocks above their 50-day SMA topped early 2013 at 89.54.
Second stage
Psychological process: Finding value becomes more challenging and investors feel attracted to “safer” large-cap stocks.
Technical manifestation: Small-and mid-cap stocks are lagging large-cap stocks.
Small-cap stocks underperformed for much of 2014, and for most of 2015.
Third stage
Psychological process: “Smart money”’ is selling stocks to “dumb money.”
Technical manifestation: Selling pressure increases behind a façade of rising large-cap indexes. Declining stocks outnumber advancing stocks.
On Aug. 2, 2015, with the S&P 500 above 2,100, the Profit Radar Report stated that we have moved to stage 2.5. Why 2.5 and not 3?
Because our stage 3 major-market-top indicator, which measures the liquidity (or lack thereof) typical at stage 3, showed a small divergence (S&P 500 moved to new all-time high, unconfirmed by demand for stocks).
However, this liquidity divergence was smaller (in terms of duration) than the divergences leading up to prior market tops (1987, 2000, 2007).