ARTICLES

Top of the Market Signs

In last week’s article, 12-Year Bull Trend, we pointed out that the bull trend was rising exponentially and ultimately that could only end with an exponential collapse. We said that the exact timing of that collapse was very difficult to assess.

You may also recall our article of 23^rd January 2021 entitled Elimination of the Bears. In that article, we predicted that the S&P, then at 3841, would rise to new record highs. The logic was that, at that stage, there were still too many so-called “investment experts” willing to call the top of the market and we gave a few examples.

Now, 3 months later, the S&P has risen a further 9% and those “experts” have already been substantially discredited. Others who now think of calling the top will be more circumspect and eventually nobody will be willing to risk their reputation on such a call, whatever they may think and even though the market will rise to increasingly ridiculous levels. When no one is any longer willing to suggest that we are at the top; when there are no more bears, run for the hills…

So, what other symptoms of the top of a great bull market can we identify? Here are some that we know of:

1. The gap between share prices and the earnings of the companies that they represent will become more and more remote until eventually there is no real connection. In a normal market, analysts carefully consider the earnings of a company in relation to its share price. The is done by looking at the share’s earnings multiple or P:E ratio. The higher that ratio becomes the longer it will take for the investor to recover what he has paid for the share from its profits.

The average price:earnings ratio (P:E) on the S&P500 is now at around 40 – which is historically high but not yet at record levels. We believe that the average P:E will go much, much higher and reach absurd levels over the next few years. You should keep your eye on the S&P’s average level as the markets go higher.

2. At the top of a great bull market, ordinary people with no knowledge of the stock market, and who would not normally get involved in shares will increasingly be investing in shares or derivatives. As the market goes higher more and more people will have positive experiences speculating in shares that they know almost nothing about. Eventually, everyone will be in the market.

A story is told of the great Wall Street bear, Jesse Livermore. He was walking to the stock exchange just before the 1929 crash when he stopped to get his shoes polished by a shoeshine. Not knowing who he was talking to, the shoeshine began giving Livermore tips on various shares. Livermore walked into the stock exchange and sold out his entire portfolio and went heavily short – on the grounds that, when the shoeshine begins giving you tips, it is time to get out of the market.

There is no doubt that more and more people are now trading the market online - directly or indirectly through various derivatives. This growing body of speculators generally do not know very much about their investments beyond the fact that they look like a way to make easy money. We expect this trend to accelerate. In a great bull market, even ignorant people will make money.

3. The “bigger fool” theory. A time will come when people buy a share not because the company which the share represents is expected to make good profits, but simply because a bigger fool will buy it back from them in a few weeks’ time at a much higher price. At this point the relationship between share prices and the earnings of the companies they represent has broken down completely.

4. Economists, even some who are highly respected, will begin to say that modern economics has advanced to the point where recessions are a thing of the past. They will argue that by using techniques like quantitative easing the government can effectively counter any recessionary trends so that the economy will continue to grow indefinitely – and, of course, the stock market will therefore continue to rise indefinitely.

This is a very dangerous illusion and one that is patently false. Nonetheless, if you keep reading the financial media (as I do) you will undoubtedly come across articles which, quoting some notable economist, will suggest that the business cycle is officially dead and that there will be no more economic recessions. Unfortunately, the truth is that in the end debts must always be settled – one way or another - and the piper must always be paid. So watch for:

• the steady elimination of the bears,
• signs that your friends, family and other unlikely people are speculating in shares or derivatives and support their involvement, not by careful analysis, but by the “bigger fool” theory,
• share prices that go far higher than the profits of the companies they represent, warrant, and
• the time when economists begin proposing that this time it will be different; that there will be no more recessions.

Go back and re-read Our Background Approach and read up on Kondratiev. And remember, for the Kondratiev wave to occur, people must first forget about Kondratiev.

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PDSNET ARTICLES

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