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What Does a Stock Market Top Look Like? An 'Intermarket' Analysis

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The following excerpt from the newly republished book "Intermarket Analysis and Investing" explains what characteristics to look for from combined economic, fundamental, and technical perspectives.

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The Economic Indicators

Leading indicators tend to show a loss of upward momentum in the economy ahead of time. Housing permits in particular tend to move ahead of any major downside period as well. The other aggregates, while considered to be good barometers of future business conditions, would tend to continue to show deceleration. Other aggregates tend to decline and confirm economic weakness after the stock market has already reversed itself. At that point, unemployment is likely to be the most treacherous indicator. Investors tend to feel assured about the outlook for the economy because of the favorable news of declining unemployment. Consumption is typically at its highest, for personal income is rising and jobs appear to be secure. Help-wanted advertisements, while decelerating, are still rising as job openings continue to be posted. The workweek is likely to be expanding, and capital spending is also increasing. Retail sales statistics are healthy, and corporate profits grow fast and remain promising. Dividends are being increased with the announcements of improving results. The coincident indicators are advancing and industrial production is expanding. Consumer borrowing is likely to be rising and savings rates falling. Thus, consumer sentiment is still optimistic, given the orderly expansion of the economy and the robust growth in almost all sectors.

Investor Psychology and the Media

Optimism abounds, household finances seem to be in good shape, and major newspapers and business magazines are reporting favorable projections in light of recently released statistics. Advisory services are bullish and the mom-and-pop investors are dreaming of making a quick killing in the stock market. Takeover activities are on the rise and the gurus of the time are providing hundreds of reasons why the market is heading higher.

The Stock Market

Volume is rising and the speculative buying of stocks with little or no fundamentals is supported by the view that the economy is expanding and it is only a matter of time before material improvement gets started. While all of this is happening, the market's breadth is likely to be showing subtle deterioration. Industry group performance is lackluster, and the number of stocks making the list of new highs for the year is shrinking. The annual rate of change for the S&P 500 (INDEXSP:.INX) has reversed its position from levels near 30 percent. The percentage of stocks trading above their 200-day moving average is declining. The put-to-call ratio is low. The good news on the earnings front is not met with a corresponding rise in securities prices. Stocks in general resist advancing on good news - most likely, the news has already been discounted. One or two broad-based averages might have signaled major divergences as they stop confirming the Dow Industrial's (INDEXDJX:.DJI) new highs. Interest-rate sensitive groups, such as banks, savings and loans, utilities, homebuilding, and insurance companies are likely to be displaying the early signs of weakness that precede the final high. The rally of the averages is likely to be characterized by an advance in a narrow list of stocks, as leadership is missing.

Amid many healthy economic statistics - a great deal of optimism, rising earnings, increasing dividends, a positive job market outlook, and a favorable forecast opinion - the stock market slowly makes its highs. In most cases, the form of the topping process is rotational. This means that some groups will deteriorate while others are still advancing, which gives the false impression of strength.

One way of recognizing the topping action is to review a chart book and see how stock prices are behaving relative to their long-term moving average. It is also important to analyze the reaction of a large number of stocks during market rallies. If the majority of stocks that an investor is monitoring fail to participate during market strengths - meandering around the 150-day moving average - and stocks do not advance on rising earnings reports and increasing dividends, the top of the stock market cycle, as strange as this might sound, may be at hand. The early signals of an impending major trend reversal are generated from the market's internal dynamics themselves, long before economic or fundamental statistics reflect them. This is why the efficient market theory is correct. Its followers are most likely relying on the published reports that are well known to any diligent investor. Because very few Wall St. speculators have the depth of knowledge to investigate and recognize all of the internal and external factors, the majority of players fail to see the top as it is occurring.

Twitter: @pensionpartners
No positions in stocks mentioned.

This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

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