Is this the peak of the bull market?
Jonathan Davis says it is always difficult to call the top of a share price boom — but professional investors know the signals to watch Conventional wisdom in the investment world is that it is hard, if not impossible, to call the really important turns in the stock market. You will struggle to find a professional investor who admits to being any good at market timing, and even more so to find a finance professor who will do anything but deplore those who have the presumption to try. In Winning the Loser’s Game, his brilliant analysis of the investment business, the American consultant Charlie Ellis speaks for the wise when he counsels private investors, ‘Market timing is a sin. Don’t ever try it.’ Warren Buffett agrees. The 24,000 shareholders who made the annual pilgrimage to Omaha, Nebraska two weeks ago to hear the great US investor discourse at his annual meeting, know not to expect him to pronounce on which way the stock market is heading next. Calling the short-term direction of the markets, says Buffett, is a mug’s game. Even at the height of the internet bubble in 2000, when market indices had reached what he knew (and said) were patently unsustainable levels, Buffett’s public stance was still that it was not impossible that the Dow Jones index would go higher in the short term. Keynes, as so often, had it right when he observed that markets can stay irrational longer than most investors can stay solvent.
In practice, however, what smart investors say in public is not always quite what they are doing. Most professional investors spend a disproportionate amount of their time and energy at least thinking about market timing. This may not be so for Buffett, who has made his reputation from buying and holding investments for years at a time, but for most fund managers and stockbrokers, whose financial rewards depend on how well they can call the short-term gyrations of the market, it is a very different story. When stock markets turn, the kind of shares that will do best change too, and professionals who don’t move with the turn will quickly start to lag in the performance league tables.
And although there is little academic evidence that market timing works, my experience is that smart money can be surprisingly good at calling the turns. The end of the bull market in March 2000, for example, was called to the day over lunch by the veteran investor Jim Slater. Anthony Bolton of Fidelity, widely regarded as the City’s most successful fund manager, repeated the feat three years ago when he told an audience of IFAs that his gut instinct was that a new bull market had begun, at a time when few others were publicly saying anything of the sort.
All this helps to explain why for most of 2006 so far, while many private investors have been venturing back into the stock market, many professionals have been asking themselves a rather different question: ‘How long can the current wonderful bull market last?’ However cheerful the public comments that marketing departments mail to investors during the ISA season, most professionals know in their hearts that the current bull market in equities is close to its peak, if only because the story has become too good to be true.
If you look at the FTSE All-Share index, for example, until last week it had risen steadily for three years from the trough of the bear market in March 2003. What’s more, it has done so without serious interruption. There has not been one correction (market euphemism for a decline) of more than 10 per cent for over three years. Volatility, a widely watched indicator, has fallen to an all-time low. This is not the way that the stock market is supposed to behave, or indeed has done in more than a century of its history. Shareholders earn their superior returns because shares are riskier, not more predictable, than other mainstream assets.
In any event, after a strong first quarter this year, many old hands think we have now reached a point when the stock market will turn direction for a while. With central banks raising interest rates further than most optimists had expected, bond yields rising and clear signs of speculative excess in many of the commodity markets, the past week’s dramatic gyrations in both shares and commodity prices are well overdue. It has become a matter of when, not if, both stock and commodity markets will stem their recent heady rises.
Even so, as Buffett and Keynes attest, there is no foolproof way of knowing when markets are reaching a peak. Anecdotal pointers such as barbers tipping stocks, though much loved by armchair market pundits, are rarely conclusive. The most reliable way to spot market turning-points is to follow the price action in the market — in other words, to look carefully at trading patterns. Just as nobody formally admits to market timing, so few professional investors admit to wasting much time on technical analysis, as the study of market charts is known.
Yet in practice all traders, and many longer-term investors, do use charts as a way of spotting potential turning points in the market. David Fuller, one of the best analysts around, teaches classes on how to spot the defining features of trend-ending market turning points. Whichever type of financial asset you look at, they tend to fall into one of three main patterns. The most scary ones are those where prices start to spike upwards at a much faster rate than before. Just such a move has taken place in recent weeks in the prices of industrial and precious metal com modities such as nickel, zinc and silver (see graph), and in many emerging markets.
Fuller’s view last weekend was, ‘I am looking for a medium-term correction [in stock markets], which could be nasty, but should be over before the end of October and possibly much sooner, depending on events.’ Anthony Bolton told financial advisers last week, ‘I think we are close to the peak of this bull market.’ These wise guys know that crazy markets could still prove them wrong by rising to new highs again next week, but you would be unwise to bet on it at this stage.
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