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

Michael A. Gayed
Mon Jan 13, 2014 10:48 EST

In 1990, Michael E.S. Gayed, my father, published Intermarket Analysis and Investing, which outlined how to integrate economic, fundamental, and technical trends into the investment process. By integrating all three types of analysis into a sensible framework, his book exposed the inherent shortcomings of relying too heavily or exclusively on any single approach. Each school of stock market analysis is thoroughly examined so that the reader can understand each method and how they interact with other approaches.

The book has been out of print for over two decades, but I've spent the last year working to get it re-released for readers interested in the thinking and methodology behind my father's strategies (which I've naturally adopted). The analytical tools presented are as relevant today as they have ever been and provide context for how to look at the entire investable landscape to help identify profitable trading opportunities, analyze the interplay of stocks, bonds, commodities, and currencies, and increase one's longer-term success.

The following is an excerpt, used by permission of the publisher.


Major stock market reversals do not follow set rules; however, when a large number of economic, fundamental, and quantitative factors are monitored, better forecasts can be achieved. Here, we will address such indicators as interest rates, commodities prices, the bond market, economic indicators, investor psychology, and the stock market as they demonstrate typical market behavior. To organize the analysis, some of these indicators can be separated into categories.

Interest Rates

Near major cyclical peaks, rates have already been on the rise or are beginning to show signs of accelerating upward momentum. Additionally, inflationary pressures rise and the Fed fights unequivocally to raise prices. Short-term rates are likely to have gone higher and faster than long-term ones. Such a condition leads to an inverted yield curve, which signals the potential for a period of economic contraction ahead. The rise in short-term rates, such as the 3-month Treasury-Bonds and the Federal Funds rate, leads the rise in the prime, mortgage, and discount rates. The short-term rate rise's effect rapidly slows down business activities in all sectors of the economy.

Commodities Prices

Raw material prices are likely to be on an upward course because supply is unable to satisfy demand. The rise of commodities prices, especially industrial raw materials, combined with constraints in capacity utilization (usually exceeding 80%), indicate congestion in production, which fuels inflation. When judging the trend of commodities prices, it is important to differentiate between strength in a limited number of them or a widespread rise among industrial, energy, and food items. It is also crucial to analyze the price rise's cause and to determine whether it is due to seasonal factors or to a surge in consumer demand that existing capacity cannot satisfy. The CRB index's trend should be closely monitored, as it might foretell the future direction of commodities prices and reveal the outlook for inflation.

The Bond Market

The fixed-income sector leads the stock market near major cyclical peaks. As the economy reaches a mature stage of its expansion, accompanied by rising inflation, bonds are likely to be in a downtrend. The rising rates and advancing commodities prices are not welcome developments for the fixed-income market. The competition from short-term money market alternatives and the inverted yield curve foretell of an impending period of credit risk in the making.

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 as 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 has reversed its position from levels near 30%. 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 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.

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