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A look at parabolic rallies from market history (and the crashes that followed)

The current bull market in the Dow:

In recent weeks, the rally in US stocks has accelerated. By any statistically valid valuation metric, the broader stock market is now more expensive than ever before, including 1929 and 2000, and way above 2007 multiples. Zero percent returns from now to 2030 are baked in the cake. Prices however are tied fundamentals with a very long rubber band, so there is no telling how high a rally might go or how long it might take to correct an overpriced condition. As momentum traders, we don’t pay much attention to valuation, because to trade on value is to be continually frustrated – either that Mr. Market is stupidly overpaying or that he is too timid to appreciate a bargain. We only look at patterns, or rather we let our algorithms assess the odds one month at a time. And so long as a bull trend is intact, the odds are with the crowd. Only when a trend has convincingly broken do the odds shift towards a decline, and only then does valuation come into play, as the extent of the decline is strongly influenced by the starting valuation. 

With that, let’s take a look at some prior moments in history where a well-established bull trend accelerated to new heights. Note that these are log scales (in linear charts, even steady exponential growth forms a parabolic slope, but we are looking for an increase in the rate itself).

The Dow in the late 1920s (note that as stocks were very overpriced, the crash of ’29 seen here was only the first phase of an 85% decline into ’32):

The Dow in the mid 1980s (stocks were overbought, but fairly priced, so the decline stopped with the crash of ’87):

The above two charts were eerily similar, a pattern noticed and famously exploited by Paul Tudor Jones, who traded both the rise and the crash with great success.

The NASDAQ in the late 1990s (lead to an 85% decline by 2003):

China in the mid-2000s (72% bear market):

The Nikkei in the 1980s (not quite as pronounced here, but I’ll throw it in as one of the great bubbles of modern time with a peak CAPE of 80 and an eventual bottom at -80%):

The two silver bull markets (30 years apart):

Gold in the late 70s (eventually bottomed at $255 in 1999):

Oil in early 2008:

Wheat around the same time (all commodities were in a bubble really – the dollar was down and Peter Schiff looked like a genius, until he didn’t):

Here’s the GSCI Commodity Index:

We can see the same thing in Bitcoin of course (it’s hard to see here but the decline since early Dec is already 50%):

Acceleration is neither necessary nor sufficient for a bull market to end and crash, but it is common before major crashes (declines of 40% or more), especially when coupled with overvaluation. It is produced by a feedback loop, wherein more and more investors jump on board with ever greater eagerness, until funds and fools are exhausted. Such tops commonly end more abruptly than when markets slowly lose momentum and churn sideways before accelerating to the downside (see the Dow below for its protracted top in 2000), so even momentum traders should exercise extra caution in today’s condition.

That’s all for today. Trade safe, and don’t hold onto this market when it turns.

 

PS – Note that most charts here are from stockcharts.com, the best free resource for long-term charts on global stock indices and commodities.

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