Time for another run through the checklist of typical cyclical bull tops in stocks.
1. Market valuation excessive
Second highest market cap to GDP valuation outside of 2000, the 4th highest Q ratio valuation and 4th highest CAPE valuation in history, last two years gains more than 80% multiple expansion and less than 20% earnings growth – CHECK
2. Evidence of overbought and overbullish extremes
II bears highest since 1987, II bulls highest since October 2007, CS Risk Appetite US model into Euphoria; Citi Panic/Euphoria model into Euphoria; Put/Call ratio at extreme low; Second highest ever Skew reading; Greedometer at extreme; Margin Debt at all-time record; Twitter up 80% in a month to a $40bn market cap despite zero profits – CHECK
3. Major distribution days near the highs
In total in 2013 we have had just one major accumulation day and seven major distribution days, which is divergent and atypical for a bull year; We should see further distribution days once the current melt-up breaks – WATCH
4. Rolling over of leading indicators
ECRI WLI is in a downtrend, OECD-derived leading indicators and narrow money point to a topping out at the turn of the year, whilst CB and Markit leading indicators still show strength – MIXED
5. Excessive Inflation
No, we are instead flirting with deflation, in line with demographics trends, which is a potentially bigger threat to a stocks bull but historically atypical. However, commodities remain on the cusp of a potential breakout and a potential typical late cyclical outperformance, whilst the US dollar is potentially flirting with breakdown, which together could provide a short inflation shock; If commodities instead break down, then that should ensure the drop into deflation – WATCH
6. Tightening Of Rates
We see this in the recent sharp rise in treasury yields, touching 3% yesterday; This development is echoed in bond yield rises in both developed and emerging markets globally; Plus China is actively trying to reign in its credit excesses by tightening, which led to the recent cash crunch issues – CHECK
6. Cyclical sectors topping out before the index top and money flow into defensives
This bull market has been dominated by flows into low-beta, dividend paying defensives, which again reflects demographic choices, whilst cyclicals have been more shunned, thus making this indicator less potent – so more N/A
7. Market breadth divergence
We see some breadth divergences in stocks above 200MA in place now for several months, whilst similar divergence in Advance-Declines has been reset by the strong rally of the last two weeks – MIXED
8. A Topping Process/Pattern – I want to focus on this, so:
We see evidence of a ‘blow off top’ pattern. Parabolic shape on the indices long term view. Corrections increasingly shallow. Permabears capitulating and converting to bulls. Perception market can only go in one direction. Euphoria.
Blow off tops increase the likelihood of a crash, rather than a more leisurely ‘topping process’ range. There are some well known examples from history, and they display a similar technical unfolding to each other.
Source: Financial-Spread-Betting. Their labelling, but others might recognise the pattern as a kind of wedge-overthrow-top, or a blow off top, where the final rally beyond the consolidation range is the blow-off part, characterised by euphoria and capitulation.
We see a similar pattern unfolded into the Nasdaq’s 2000 peak, and also on the Nikkei’s 1989 top:
On a longer term view, we see a parabolic rise and collapse, but it’s in the Daily view action prior to the collapse that we see the clues in the pattern.
The Dow today:
The pattern is there, the euphoria is there. A little more breadth divergence would be more compelling, but this could potentially accumulate into the ‘second chance’ point.
So increased chance of a market crash ahead, and if we draw on history again then the combination of a sharp sell-off together with the record high leverage extremes currently in play (margin debt, Rydex), suggest an episode of forced-selling and margin-calls similar to 2008 or 1929, where little will be spared.
Here is the bigger picture for the 1929 crash. Note that all assets sold off together in the crash down to where I have marked a blue circle. After that, gold stocks took off and diverged from the bulk of equities which progressed into a bear market.
Source: Financial-Spread-Betting
Therefore, although I expect precious metals and miners to return to a bull market as equities top out here, we have to be aware that a market crash could see EVERYTHING sell off due to forced redemptions (1929, 1987, 2008), before PMs can take off in earnest.
S O L A R C Y C L E S 
hi again John,
interesting post, and like I said yesterday I’m not questioning your tehnical analysis but I’m wondering on how one could actually make some money out of this potential downturn? The obvious answer would be to buy some put options, but out of experience I’ve found out that you actually lose more money than you make because of timing issues. Like you point out in your charts, the stock market has a tendency of going sideways between the “shake out” and the “second chance” points usually that’s a VERY frustrating time for investors going short with a lot of fake-outs and position covering, usually by the time the market finally goes all the way down your options will probably have expired and your trading account will be dry… Then usually people will do everything to buy more put options trying to get in line for the “next big one” except that next big one never comes, on the contrary, after a spike the market goes back up, proving to be an even more disastruous trade. So my question (to you and other traders around here): how do YOU plan on making a profit off of this?
I use spreadbetting with no expiry. But also short ETFs and long Vix.
Add stops into falls and hold, I should add. I’m not looking to trade in and out for quick returns. Am playing for the big prize.
i think what you want to know is if other traders using their tools see the conditions met that they too would take a large short position.W
when I do I will do a post saying I agree…
Answer = trade the indices one day at a time (day trade).
I understand there will be a major crash coming up, but I also believe it is still a bit early to expect one now. Maybe 3 more months later and we’ll see one.
A nasty correction should occur immimently (not a crash). Analogs aside, sentiment, call/put etc all call for a ‘proper’ sharp correction in the near future. The exception to this is if we had an external shock, e.g. China credit stress explodes, then we could see a crash rather than a correction due to the leverage, sentiment etc.
But if we draw on those patterns above, the timings were similar in each case, a sharp correction imminently, then a retrace/consolidation for around a month should follow that, then a crash after that.
Do you have research on put call ratios predictive power for the market. Appreciate if someone can share this. Thanks
Thank you for all the work you put into this site. God bless.
Thanks
Awesome work. Can you explain little bit more on spread betting. Can we do it on Interactive broker. Thanks for all your hard work. My major concern is this can take a longer time because of all the co-ordinated central bank effort. In all the past scenario it was never a co-ordinated effort like today.
Thanks. It’s only available in certain countries. If you are in the US it’s not.
John, imho this is one of your best discussions. And you are correct about the precious metal stocks FIRST declining w/the general market. Both Dome and Homestake topped out in August, 1929 (a little ahead of the general market) and bottomed in November, 1929. It’s a little difficult to understand; but at the time Dome was in a general downtrend; and Homestake was in an uptrend. But, November, 1929 represented the lowest risk entry point for both. HM retested it’s lows in 1930; and Dome in 1931; so initially there was a lot of backing and filling before prices moved directionally to the upside. History would suggest, (using the 29 experience anyway) that there could first be more pain to the downside
My trader friend advises that day trade needs no memory or forecast. Many opportunities are lost and many inevitable wipe-outs avoided. It appears that during the 2013 background the sentiment of forecasts has been increasingly negative. The markets have totally ignored all. If someone who had been forecasting correctly would now shout so loud, maybe some more would take note. Meanwhile it is just business as usual, with the ever present promise of a correction.
Nice work John.
S&P 1921 is 1.38 times the move from the 2007 high to the 2009 low.Also, Chris Kimble has spotted a long term trend-line targeting 1929…sorry, couldn’t find the chart link.
Given the positive lunar conditions (with the New Moon and major Bradley date both falling on the 1st Jan) it is reasonable to expect further upside into the back end of next week/ early w/c 6th Jan, possibly targeting this area in a blow off. It looks a big ask but that is the nature of blow off tops.
If the market top is directly ahead of us, then price will likely push sentiment and indicators to extremes so low leveraged “starter” positions might be advised.
GL
TDL
Thanks guys
Although referencing past price action is as useful as a chocolate tea cup, I have a pic which shows a bull markets which outlived many peoples’ expectations. The graph linked below shows a combination of the FT30 and the FTSE 100, from 1972 to 1983. As you can see, the market bottomed in late 1974, and soared up, year after year.
It shows an interesting parallel with how the DJIA + S&P 500 have been on a strong upward trend, since 2009. If we did an equal time scale, with a 34yr comparison, the price action of 2013 would be akin to the FTSE in 1979, when it was at about 500-600. By 1983, it had soared to 1000, and there wasn’t a full-blown bear market until 1987, well over 12yrs after the 1974 low.
http://twitpic.com/dq7k5s
Who knows, maybe the Dow could end up at +20,000 or something, by 2017? The comparison doesn’t work entirely, given the irrational exuberance of the 80s boom, which was fuelled by privatisation, plus the ZIRP-inflated Dow of today, but it does go to show that bulls can last for at least a decade.
“And traders watched in disbelief as the market kept rising…”
http://www.thestreet.com/story/12181919/1/91video93-quick-take-stocks-to-pull-back-in-early-2014-then-gain-for-the-year.html?puc=yahoo&cm_ven=YAHOO
Bullish for me 🙂
Stocks to pull back it says…
As one of the famous trend-followers has said something like everyone gets what they want out of the stock market…so I wish everyone is happy.
Happy new year to all the bulls and bears alike.
To Robert,
Less is more.
To John,
I wish the best to you over the coming year. May yr 2014 provide abundant success and happiness.
PS: Taking fliers on ANV and MUX.
To Rick L. Where is your stop, target and position size in that trade? Thinking of shorting those names on pumps.
I also wish you success and happiness. God bless.
Thanks Rick
John,
Will the stock market decline be short and deep, not lasting for more than a year or do you expect a stock market decline lasting years? I ask because the following article explains market cycles that may indicate an up year beginning 2015: http://www.marketwatch.com/story/three-cycles-to-watch-in-2014-2013-12-23
In the article, the most interesting indicator is that years ending in 5 are the most bullish. According to the article, since 1895, the average return for year 5 is 28.9% and every fifth year has been positive 11 out of 12 decades.
After 2015, comes the 17 year market cycle that may usher us into a new secular bull market.
Jack
Collective demographics are down for a few years yet, but depends how fast and deep a bear is.
I’m a fan of sales indicators. Here is a chart of 1987 (SPX).
http://s14.directupload.net/file/d/3486/9i828awq_jpg.htm
And here today (Dow):
http://s1.directupload.net/file/d/3485/6qhankl5_jpg.htm
John,
.
I have been reading your last half dozen posts in one go – absolutely excellent as always and a large amount of food for thought. My life savings are long so I have some serious fretting to do!
Sincere thanks for your hard work and generosity in sharing this with us.
Hopes for 2014: (a) most of us step onto the up/down escalator at about right time
(b) the excellent replies to your posts continue – though hopefully not too messianic – Gotta keep an open mind!
Thanks Charles
essence of trading..find a method that works for you and stick with it…
http://stockbee.blogspot.com/
For me the top is around the corner, similar structure 1909-16-19, overcoming upward wedge(logarith) in the past. Dow Jones target> 16.500-17.000+>http://forosdebolsa.com/foro/foros-de-bolsa/1112630/dow-jones-reaching-upward-wedge-in-logarithic-must-overcome-as-1909-16-19/
@apanalis
Thanks all for your input
John,
Just wondering when you say imminent correction, does it mean starting 1st week of jan. When are you expecting it to start. I dont see any catalyst untill earnings seasons. What possible catalyst are you seeing.
Thanks
Bill
I have generally covered what each individual indicator that is currently extremes has delivered in the past, whether by chart or data. With every day that passes…
‘We see evidence of a ‘blow off top’ pattern’.
John, I think personally that you force a scenario into the market because you want it badly to happen. As to the examples of parabolic tops : all of them were very fast markets, faster than it is today, secondly, they all went much higher percentage wise from ‘primary distribution’ before topping, therefore I would say that your forecast is less likely than a much stronger market ahead in terms of time and also size. Of course you may be right. When the price starts to make lower highs I will be right there to stick in some short positions.
Happy and prosperous 2014 to everybody! I love the market not because it is exciting but because it keeps me from I hate most : employment and a boss panting over my shoulder. Whether you like or dislike the market, I hope it helps you all in your endeavors!
Despe, I was neutral and low-exposed in equities positions before my recent analyses. If I have a natural markets bias, and everyone does, it is bullish. Your assessment would be applicable to a permabear.
I know that you’re not a permabear, but IMO your bias is contrary to current market conditions, this is what I mean. The stock prices may of course start to decline right away tomorrow, but in my view it is not very likely.
Thanks for the great work.
Just one comment to add is that all three of the historical crashes that you posted above had very similar structures in terms of time as well as price.
The second chance retracement tops all occurred 23-27 trading days after the top.
The crash low (not final low of move) all occurred 36-40 trading days from the tops.
My point is that if the analogy holds it will be easy to monitor if it is playing out and when to ante up, etc.
Thanks, yes noted too, both pattern and timings.