Thus was supposed to be automatically posted while I was out hiking the Appalachian Trail last week. It ran afoul of a software glitch (mine, I think.) I wrote this before I left on my hike. Since I wasn’t eaten by bears, I’ll be back posting as usual today, Monday, May 8.
With Apple (AAPL) and Facebook (FB) set to report on May 2 and with the NASDAQ Composite climbing above 6,000 for the first time ever, it’s a good time to look at, yes, the health of this market, but also the state of our worries.
It just a fact of our mental lives that most of us start to worry when markets hit new records. Surely, we say, a record means that stocks are about to fall as we “revert to the mean,” whatever that means.
Barry Ritholtz, founder of Ritholtz Wealth Management, and a columnist for Bloomberg, looked at what we know about record highs and market tops in a recent column for Bloomberg and for his own blog, The Big Picture. (Check out The Big Picture at ritholtz.com. Ritholtz asks and answers interesting questions. )
Ritholtz starts with the often-stated and often forgotten bit of wisdom that “overvalued stocks can and do stay overvalued for long periods of time. In the mid-1990s, pricey stocks became even pricier, with the S&P 500 notching high double-digit gains for five consecutive years (1995 = 34%; 1996 = 20%; 1997 = 31%; 1998 = 27 %; and 1999 = 20%).” (I’d also add that over-priced stocks finally collapsed into a huge bear market in 2000.)
He also notes that market “history informs us that when [interest] rates rise from low levels during periods of modest inflation, stocks tend to do well about three-quarters of the time. More dangerous for equities are those periods of rising interest rates amid high inflation.”
But to me, the most interesting part of Ritholtz’s post is his look at research by Paul Desmond of Lowry’s Research on market tops and narrowing markets. Desmond’s paper “Identifying Bear Market Bottoms and New Bull Markets” won the Market Technicians Association’s 2002 Charles H. Dow Award.
“Desmond has analyzed every major market top since 1925, looking for consistent warning signs of an approaching bear market. He notes that “’in virtually every case the warnings appear as a persistent divergence between the S&P 500 making a series of new highs, while market breadth makes a series of lower highs, showing that stocks are consistently dropping out of the bull market.’” This process of narrowing has lasted anywhere from four months to two years.
So the most important market condition that we should be watching for right now is this narrowing. If the market index (or indexes) are still going up, but the number of stocks leading that advance is falling, then we should, indeed worry. But, Desmond told Ritholtz in an e-mail exchange, that’s not what we’re seeing right now. Yes, the big name NASDAQ stocks such as Microsoft, Apple, Facebook, Amazon and Google have been leading the market higher, but the other stocks in the index are keeping pace. “Desmond notes that Nasdaq 100 and Nasdaq 500 advance-decline ratios are at new bull market highs. That sort of broad-based market participation isn’t indicative of the end of market cycles. ‘The bottom line,’ Desmond told Ritholtz, ‘is that there are no significant early warning signs of a major market top at present.'”
Ritholtz also notes that the NASDAQ Composite has hit new highs only in nominal terms: Adjusted for inflation, the Wall Street Journal calculates, the NASDAQ Composite is still off 1171.07 points from its March 2000 peak, which is 7196.56 in March 2017 dollars.