Bull markets usually don’t end with much fanfare
Unlike bear market bottoms, which tend to be short and violent, bull market tops in the stock market tend to occur gradually over time, as one sector or investment pattern peaks and falls, and then another.
This means that investors should not manage their stock portfolios assuming that there will be a specific day before which it would make sense for the investment to be 100% and after that it is in cash. Even if the timing of the stock market was not incredibly difficult, it would still make sense to build cash gradually as individual positions achieve their goals.
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Of course, there’s no way to know if the current stock market — which slashed brutally from record highs in late September, prior to Friday’s rally to start October — has gone through such an extended process. But the bull market will end one day, if it isn’t already, and it’s important to review the characteristics of previous peaks so you don’t manage your portfolio assuming you’ll be able to catch the top. At present.
A recent example of not all sectors and patterns reaching bull market highs at the same time appeared at the top of the internet stock bubble in the early 2000s. Although the S&P 500 and Nasdaq Composite Indexes reached bull market highs in March 2000 Value stocks – and small-cap stocks in particular – continued to rise. The S&P 500 was at an October 2002 bear market low 49% lower than its March 2000 high, the Nasdaq was 78% lower, but the average value of small stocks was 2% higher than it was in March 2000, according to data from Dartmouth professor Kenneth French.
A look at 30 bull markets
While this is just one example, it is not unique. Consider what I found when analyzing 30 bull market tops from the mid-1920s that appear on the calendar maintained by Ned Davis Research. In each case, it identified the dates when different market segments reached their highest levels in a bull market: large, medium, and small segments, as well as patterns of value, growth, and blending, according to stock price ratios to the book. On average across all 30 bull market peaks, there was a 225-day difference between the earliest date any of these sectors reached their peaks and the most recent. That’s more than seven months.
There are exceptions, especially when an external event causes the market to crash and almost all sectors chime in. A good example is the stock market crash of 1987, as well as the declines following the September 11 terrorist attacks and the pandemic shutdowns of March 2020. But in most cases it is more accurate to view the top of a bull market as a process rather than a single event.
Another reason to view market tops as a process is that it’s unlikely that on the day broad market indices like the S&P 500 hit bull market highs, you’ll have any idea that a bear market is approaching. Instead, you are more likely to be caught up in the exuberance of the moment. Only later will it become clear that the bear market was in the process of taking off.
This abundance causes investors to invest heavily in stocks during the last stages of bull markets. Believing that the exact day of the top had not yet been reached, they held onto their stock positions for far too long. Viewing market tops as a process can counterbalance this exuberance, as it leads investors to focus on their individual positions rather than the market as a unified whole.
Many resist this advice because their memories play tricks on them, leading them to believe that it is possible to identify the top of a bull market as it happens. That certainly isn’t the case, according to my company’s daily tracking of stock market watchdog advice—advisors who tell clients how big their portfolios of stocks should be and how much cash they have. On those days over the past four decades when the S&P 500 hit a bull market high, the average recommended stock exposure level for these timers was 65.7%. This is an exposure level above 95% of all other days over the past 40 years.
In those days when the S&P 500 hit bear market lows, by contrast, the average recommended exposure level for stock market timers was just 5%.
Memories of 2007
Think back to October 2007. Even though the S&P 500 was about to embark on a 16-month decline of 57%, none of the nearly 100 stock market timers my company was watching envisioned anything like this.
This failure was true even of those using timers on the market with the best long-term records emerging that month. One of the best long-term performers at the time was telling clients that a bear market was such a remote possibility that it wasn’t even on his radar screen. Another moved from full investing to going 25% on margin — borrowing to increase equity investment — the day before the day the S&P 500 bull run was set.
If those market professionals with good long-term track records are unable to anticipate the start of one of the most dangerous bear markets in US history, you are kidding yourself if you think you can consistently do anything better. You are more likely to be successful by viewing the end of a bull market and the beginning of a bear market as a process rather than a single event.
Mr. Hulbert is a columnist who tracks Hulbert Ratings investment newsletters that pay a flat fee for their review. It can be accessed at Reports@wsj.com.
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