Veteran UK investor Jim Slater is known for his penchant for high-flying growth shares. But that doesn’t mean he’s always optimistic.
Slater has lived through many market cycles in his five decades of investing, and like any great investor he knows that shares go down as well as up.
Back in 2008 I found his signs of a bear market bottom a useful waypoint in navigating the slump.
But Slater has also shared some tips on how to spot a bull market top.
Predicting the next move in the stock market is notoriously difficult, if not impossible. (Remember the Vanguard study that showed that pretty much all methods of forecasting market returns were useless?)
And calling an end to a bull market is even more dangerous than doing the same for bear markets.
With a few notable exceptions1, stock markets have always bounced back from big corrections.
You might have to wait for a few years for your guess that a bear market will come to an end to prove right – perhaps long enough for you to have really got the call wrong – but all bear markets ended eventually.
The opposite is not true of bull markets.
Despite what some cynics seem to think, markets are cyclical over the short run, but in the long run they tend to rise higher. The UK and US markets stand far, far above their levels of 30 to 100 years ago.
If you predict a market is due to pause or fall – which is what calling the top of a bull market amounts to – then you are betting against this trend.
So timing is all-important.
Signs of a bull market top
Most of us will do better not to try, but for those who want to have a stab at stock market prognostication, here are Jim Slater’s signs of the top of a bull market.
(Note: My comments are in italics).
The ‘rubbishing’ of cash and the consequent low institutional holdings are an obvious danger, signalling that most funds will be fully invested. Does this hold after a period of 300-year lows for interest rates? I’d bet not, but Japan’s experience says otherwise.
Value is hard to find
The average P/E ratio of the market as a whole will be near to historically high levels. The average dividend yield will be low and shares will be standing at a high premium to book value. Some people would prefer to look at the cyclically-adjusted P/E ratio here, though I’d be cautious.
Interest rates are usually about to rise or have started to do so. In mid-1995, interest rates in both the USA and UK had been rising from historically low levels. Investors were wondering how much further they would rise before topping out. (Since Slater wrote these words, we’ve seen what historically low interest rates really look like…)
Broad money supply tends to be contracting at the turn of bull markets.
The consensus view of investment advisers will be bullish.
Reaction to news
An early sign of a bull market topping out is the failure of shares to respond to good news. The directors of a company might report excellent results only to see the price of their shares fall. The market is becoming exhausted, good news is already discounted, and there’s very little buying power left.
Offers for sale, rights issues, and new issues are usually in abundance, with quality beginning to suffer and low-grade issues being chased to ridiculous levels.
The press and TV tend to give more prominence to the stock market and to be optimistic near the top. If prices appear high in relation to value, the argument is that ‘it will be different this time’. The few bearish articles that warn of dangers to come are ignored by investors.
At the peak of a bull market, shares tend to be the main topic of conversation at cocktail and dinner parties. The financial crisis has made the market a talking point for years, however, so perhaps this indicator is misleading in the current environment?
Changes in market leadership
A major change in leadership is often a prelude to a change in market direction. Near the top of a bull market, investors often move from safe growth stocks into cyclicals, which they buy heavily.
An interest study by Matheson Securities of ten stock market turning points demonstrated the stock market turned downwards on average about ten months after the unemployment figures began to fall. Remember that unemployment is a lagging indicator.
Want to learn more from Jim Slater? Check out his superb guide for small cap stock pickers, The Zulu Principle.
- China and Russia especially, but arguably also Germany and Austria. [↩]