CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. Please ensure you fully understand the risks involved. CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. Please ensure you fully understand the risks involved.

Has the market topped?

As indices hang on near record highs, and sentiment data shows bullishness at extreme levels, investors are wondering whether the market rally is exhausted.

Bull statues in front of a trader sat in a German stock exchange
Source: Bloomberg

The very fact I wrote the above title is probably a sign there is more to come in this market rally, at least over the longer term. The old journalism adage is, ‘the answer to any question posed in a headline is always “no”’. I remember my father saying, when I was young(er), that you have to be an optimist to invest in the stock market. It’s a similar point to that made by Warren Buffett, who once observed that the 20th century saw the US experience two world wars, a Depression, a dozen recessions and panics, plus ‘flu epidemics and the resignation of a disgraced president, but the Dow Jones still went from 66 to 11,4971.

We have to remember we are now in a secular bull market. Most people date the bull market from March of 2009, when the market bottomed following the financial crisis. However, a real bull market only begins when the previous record high was surpassed. For the S&P 500, the new secular bull market began in the spring of 2013, when the index passed the highs of 2000 and 2007. The last time the index took out a long-term high was in 1982, when it exceeded the 1966 high. That bull market went on until 2000. The market goes up, most of the time. Crises such as 2008 are relatively rare (although not as rare as mathematical theory would suggest), and we have, I submit, become oddly accustomed to them due to the close occurrence of the 2000 and 2008 panics. Thus, we looked for one last year, and arguably continue to do so. To flip the argument around, the secular bear market ran from 2000 – 2013, and is now firmly dead and buried2.

Much has been made of how inflows from retail investors are driving the rally at this point, and that the ‘smart money’ (institutional investors etc) have left the building. Proponents of this theory will point to the increasing abundance of stock market commentary on everyday TV programmes on the topic of how investors can make money from the bull market. Those buying now are certainly late to the post-2009 party, but if the current bull market is anything like the previous iteration, and if they have a time horizon that extends beyond the next six to 12 months, they may not be the latecomers at all.

Other commentators point to the overriding bullish readings from investor sentiment surveys, and to the ratio of put options to call options (i.e. bearish to bullish options). Yet these have been, historically, a much better predictor of bottoms than tops – elevated sentiment and put/call readings can go on for much longer than most people realise.

Finally, there is the valuation argument. Stocks are expensive on current PE ratios (i.e. using current earnings numbers), but become less so when forward PEs (using expectations of future earnings) are taken into account. Valuations do matter, but in the long run. For now the market is moving on momentum, and this too can go on much longer than anyone realises.

A helpful and recent comparison would be to 2013. Like 2017, 2013 was the first year of a new presidential term in the US (although Barack Obama was embarking on a second time, while Trump is only on his first). Both years saw the S&P 500 gain around 8% by March. Both 2013 and 2017 followed volatile periods, with 2013 starting 2% higher than 18 months earlier, and 2017 5% higher compared to a year and a half earlier. Both years also saw low volatility and significant equity inflows. At present 2017 looks to have more exuberant sentiment readings, which could be a sign of short-term weakness ahead. The year 2013 saw regular sell-offs in the 3% - 8% range, but pushed steadily higher3. Indeed, it was a trend follower’s dream, both for short- and long-term traders.

Everyone keeps looking around for the next sell-off, and indeed for the next reason for that sell-off. I would suggest that when it comes, for it will, it will probably be for an unexpected reason. And it will also provide an ideal opportunity for dip buyers. The bull market is very likely to continue, as economic growth picks up, but there will be the odd shock along the way. I leave the final words to Warren Buffet, who said:

'Opportunities come infrequently. When it rains gold, put out the bucket, not the thimble'4

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