Market Direction and Stock Trends

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What you’ll be feeling when the bull market tops out
By: Mark Hulbert | May 8, 2021

• They don’t ring a bell at market tops

You will be completely oblivious on the day the bull market hits its exact top.

In fact, chances are overwhelming that you’ll actually be happy that day, if not downright exuberant.

I offer these comments as a reality check on the comforting story that many retirees and near-retirees are telling themselves about how they’ll be able identify a market top in time to get out at or near the top. That story does allow them to remain heavily invested in equities, and so long as the market continues higher the story is reinforced and gets stronger.

But that story almost inevitably will not have a happy ending. That’s because, by definition, the news will be unambiguously rosy on the day the stock market hits its all-time high. That is why the market is hitting that all-time high, after all, and why reducing your equity exposure will be the last thing on your mind.

That’s the behavioral theory about market tops. I confirmed that this theory is true in practice by combing through my 40-plus-year database of the recommendations made by the investment newsletter industry. That database includes every issue sent by the hundreds of monitored newsletters, tape recordings of their voice hotlines, FAXes and emails sent to clients, as well as screenshots of what they had on their websites. Give me any day since 1980 and I can tell you what newsletter editors were saying on that day.

Consider what I found upon focusing on their comments on Friday, Mar. 24, 2000—the exact top of the Internet bubble. I decided to focus on that bull market top because many are drawing parallels between that bubble and the current market environment. Like investors today, many then also had given up trying to justify equity valuations; they nevertheless stayed heavily invested by reassuring themselves that they would know it when the market topped out.

They were wrong then, and you will be wrong again. Here’s a sampling of comments from newsletter editors over the weekend following that Mar. 24, 2000, top:

• “We remain optimistic on the growth stocks we focus on. You should continue to stay heavily invested in the New World stocks we recommend.”
• “We were again impressed [by the market’s strength]… To us, this is a sign that the intermediate term trend is alive and well… Our best bet is for a choppy to down market next week, but we would not anticipate a top of any real significance. Right now, we think that our trading and investment positions should remain. We continue to look for higher prices well into the summer on the important indices.”
• “Only 3% of the globe is hooked up to the Internet. The Internet will never stop growing, so stay fully invested in our recommended stocks.”
I could go on and on, but you get the point.

Unconvinced?

Consider the following comments that newsletter editors made at the end of August 2008, two weeks before Lehman Brothers collapsed and the world’s financial system came close to grinding to a halt. Other than the bursting of the Internet bubble, that collapse arguably is the most consequential event in U.S. stock market history over the last two decades.

Despite the impending doom, this is a sampling of what editors were saying then:

• “I am ready to be a bull again! … The housing market is beginning to show serious signs of a bottom… Quietly, the financial sector has been slowly healing.”
• “For the next few weeks at least, the sun seems destined to shine on the stock market… The credit crisis seems to be reaching a conclusion… All these factors have lessened the downside risk in stock prices, for now.”
• Because of falling commodity prices consumers are… going to get some much needed breathing room. This will allow the economy to regain its footing and begin a recovery.”
• The sub-prime mess is largely behind us… I think a 75% invested posture is about right at this juncture.”
I have chosen not to identify the authors of these various comments because my point is not to point out their error or make fun of them. On the contrary, they were in very good company in making these comments. My hunch is that, at the time, you were probably feeling something quite similar yourself.

My point instead is that, if these market professionals who follow the market on a minute-by-minute basis every day are unable to identify a market top, we are kidding ourselves if we think we will be able to do any better ourselves.

The investment implication is clear: If a severe bear market would inflict intolerable harm on your retirement standard of living, then you should lighten up now. One way to do so that is psychologically easier for some investors is to follow a dollar-cost-averaging approach: First determine how much you need to reduce your equity exposure to bring it down to the level you could live with through a bear market, and then divide the amount of that reduction into a number of equal-sized tranches. You would then reduce your equity exposure by the amount of each tranche each month (or quarter) going forward.

This approach reduces the regret you’d otherwise feel if you all at once reduced your equity exposure and the market continued going up. And it sets you on the path of being prepared when the next bear market begins.

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