Double Tops Not Conclusive But Raise Caution Flags

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In his fact-filled economic commentaries, Gluskin Sheff’s David Rosenberg regularly provides helpful insights. His June 20 issue of Breakfast With Dave offered some stock market information that I had never before seen, despite having paid pretty close attention over a 45-year career in the investment industry.

David argued that in each stock market cycle – at least since 1980 – “each fundamental peak in the S&P 500 actually represented a ‘failed’ peak,” with the market forming a double top at the highs. Additionally, the momentum leading up to the peak was extremely strong, averaging an 11% price increase in the preceding 30 days. He profiled important market tops in 1980, 1987, 1990, 2000 and 2007.

As an avid student of market history, I went back over those time periods and a few more, confirming David’s findings in broad strokes. Not surprisingly, although his conclusions are accurate, putting them to practical use is not quite as easy as looking carefully for the requisite conditions and acting in a timely fashion. Over the decades, there have been numerous instances in which markets have put in a potential double top after a powerful rally in the month preceding the first peak. Many of those did not initiate meaningful declines; the most recent of which was a mere few months ago. This year the S&P 500 jumped about 8% (using intra-day prices) from early February to a peak at about 1880 in early March. A slight pullback ensued, followed by a rise into the 1890’s on declining momentum in early April. While the conditions had been fulfilled, the decline that followed was barely in excess of 4%. The equity market then moved higher in the second quarter.

Experience has taught us that major market tops don’t all look alike. Otherwise, managing investments would be a much easier business. The five major market peaks that David identified did conform to the pattern he outlined. There was, however, a painful 22% decline from mid-July 1998 into October of that year that exhibited no double top, despite a 10% price runup in the month prior to the July peak. And the most devastating decline in U.S. market history, the 89% collapse from 1929 to 1932, began with a rolling single top that accelerated rapidly to much lower levels.

At the very least, David has identified a set of conditions that have historically raised a caution flag. Double tops don’t necessarily lead to major declines, but many major declines follow double tops. The danger is compounded if the initial peak is preceded by a sharp runup in prices. Rosenberg’s computation of an 11% rise in the 30 days before the first peak in his examples includes rallies that ranged from about 4% to about 17%–a significant spread. A loss of momentum leading to the second peak should also raise some concern.

As I mentioned above, these conditions were met earlier this year with no dire consequences. Today we witness similar conditions to a smaller degree. June 9 saw an intra-day peak of about 1956 preceded by a 5% price rise in the prior month. A minor pullback led to a second peak at about 1968 on less breadth and momentum on June 24. While the caution flag flies again, the market continues higher, buoyed by the most monumental monetary stimulus program in the history of mankind. The short-term outcome is uncertain, but the investing public’s overwhelming complacency feels misguided.