Bull markets usually don’t end with a bang

Unlike bear market lows, which tend to be short and sharp, bullish stock market highs tend to occur gradually over time as a sector or investment style first peaks and declines. , then another.

This means that investors should not manage their equity portfolios on the assumption that there will be a specific day before which it would make sense to be 100% invested and then be in cash. Even if the precise timing of the stock market wasn’t incredibly difficult, it would still make more sense to build up liquidity gradually as individual positions hit their targets.

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Of course, there is no way to know whether the current stock market – which abruptly retreated from record highs in late September, ahead of Friday’s rally to begin October – has entered such a protracted peak process. But the bull market will end someday, if it hasn’t already, and it’s important to review the characteristics of past highs so that you don’t manage your portfolio on the assumption that you will be able to peak in real time.

A recent illustration that not all sectors and styles are reaching their bullish highs at the same time appeared at the top of the internet stock bubble in early 2000. Although the S&P 500 and Nasdaq Composite indexes reached their bullish highs in March 2000, value stocks – and small cap value stocks, in particular – continued to rise. The S&P 500 at its October 2002 bear market low was 49% lower than its March 2000 high, and the Nasdaq Composite was 78% lower, but the average value of small-cap stocks was 2% higher than what it was in March 2000, according to data from Dartmouth professor Kenneth French.

A look at 30 bull markets

Although this is only an example, it is not unique. Consider what I found while analyzing the 30 bull market highs since the mid-1920s that appear in the timeline maintained by Ned Davis Research. In each case, I determined the dates on which various sectors of the market reached their particular bullish highs: the large, mid and small cap sectors, as well as the styles of value, growth and mix, as measured by the market. share price. -accounting rates. On average over the 30 bull market highs, there was a 225-day gap between the first date one of these sectors peaked and the last. It’s been over seven months.

There are exceptions, especially when an external event causes the market to collapse and virtually all sectors fall in unison. The stock market crash of 1987, as well as the declines following the terrorist attacks of September 11 and the pandemic lockdowns of March 2020, are good examples of this. But in most cases, it’s more accurate to view a bullish top as a process rather than a one-time event.

Sentiment factor

Another reason to view market highs as a process is that, the day major stock indices such as the S&P 500 hit their bullish highs, you will have any idea that a bear market is imminent. . Instead, you’ll likely be caught up in the exuberance of the moment. Only with hindsight will it become clear that a bear market was starting.

This exuberance leads investors to be too heavily invested in stocks during the later stages of the bull markets. Believing that the exact peak day has not yet been reached, they hold on to their stock positions for too long. Viewing market highs as a process can counterbalance this exuberance, as it causes investors to focus on their individual positions rather than on the market as a monolithic whole.

Many resist this advice because their memories play tricks on them, leading them to believe that it is possible to spot a bullish top the moment it occurs. This is definitely not the case, based on my company’s daily monitoring of advice from stock timers, advisers who tell clients how much of their investment portfolios should be in stocks and cash. Over the past four decades in which the S&P 500 peaked in the bull market, the average level of exposure to equities recommended by these timers was 65.7%. This is a higher level of exposure than 95% of all other days over the past 40 years.

On days when the S&P 500 hit its lowest bear market level, by contrast, the average exposure level recommended by stock timers was only 5%.

2007 memories

Remember October 2007. Even though the S&P 500 was on the verge of entering a 57% 16-month decline, hardly any of the 100 or so stock stopwatches my company monitors were considering anything. the type.

This failure was true even for market timers with the best long-term records entering that month. One of the long-term top performers at the time was telling clients that a bear market was such a distant possibility it wasn’t even on his radar screen. Another went from full investment to 25% margin – borrowing to invest even more in stocks – the day before the exact day of the S&P 500 bull market high.

If these market professionals with good, long-term track records weren’t able to anticipate the onset of one of the most serious bear markets in U.S. history, you’re kidding yourself if you think that you can always do better. You are more likely to be successful by viewing the end of a bull market and the start of a bear market as a process rather than a one-time event.

Mr. Hulbert is a columnist whose Hulbert Ratings follows newsletters on investments that pay a fixed fee to be audited. He can be contacted at [email protected]

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