Spotting bull market peaks is difficult, some say impossible.
The problem is that they occur relatively infrequently. There were just two dozen significant declines in the last century. Most investors have little personal experience with them.
Another problem is that normal stock market ebbs and flows often muddy the water. Shares usually zig and zag, even during a powerful bull market. Individuals typically can not distinguish between a temporary dip or the opening leg of a full-fledged bear market until it is much too late.
Commentators often reassure investors that a bear market downturn is unlikely because underlying economic conditions are sound. They ignore an important fact. The stock market often turns a blind eye to economic conditions. Bear markets occasionally occur despite positive economic conditions. Some bull markets have occurred in the midst of horrible conditions.
Recall the late-1970s bull market rally that took place in the middle of a poor economic environment featuring recession, high inflation and uncontrollable labour union excesses. Looking back in time, the rally appears to have been triggered by the hope that the Conservatives, led by newly installed Margaret Thatcher, might win the next (as yet uncalled) election.
More recently, the bull market rally of 1990 to 1992 began in the midst of a collapsed housing market, double-digit inflation and the start of the first Iraq war.
And who can forget the bear market of 2000-2003 when UK shares lost half of their value. No one warned that an economic slowdown was about to occur until well after the stock market decline was underway.
These observations make the clear point that spotting stock market turning points by relying upon economic forecasts is a tough game to play.
During periods of uncertainty, one tool worth thinking about is historical analysis. History is not a precise forecasting tool – far from it. But it does provide a useful perspective by raising yellow-flag warning signals.
A good example is based upon the -4.6 per cent fall on the FTSE-All Shares index in the 15 trading days from April 21 to May 15. Despite May's poor reputation, prices rarely fall so steeply near the start of the month. This year turned in one of the bigger 15-day declines since accurate daily records were first collected in 1936.
Trading conditions associated with previous big declines at this point on the calendar are worth thinking about. There were 10 other big late-April to mid-May declines since the Great Depression. Seven occurred during bear markets. They ranged in pain from a 27 per cent drop in 1951-52 to a whopping 73 per cent decline in 1972-74, the biggest drop of the last century.
It is not common knowledge but these seven big April/May drops were usually linked to painful Budget Day announcements a few weeks earlier of rising taxes or rising interest rates.
Two other painful April/May declines occurred in 1953 and 1986. Neither one turned into a full-fledged bear market. It is worth noting that the Spring Budget in both years featured significant tax cuts.
The sole exception to this budget-linked trend occurred in 1983. According to George Blakey's The Post-War History of the London Stock Market, that year's June election played a significant role in creating this exception. Labour's Manifesto pledged withdrawal from the European treaty, a far-reaching re-nationalisation programme, exchange controls and drastic increases in public expenditures. The financial markets took fright in early-May (accounting for the big decline) but quickly regained composure once it became clear in mid-month that the Conservatives would return to power with a solid majority.
On balance, the historical evidence associated with painful late-April to Mid-May declines is plain to see. Putting political triggers aside, painful stock market drops at this point on the calendar typically occur during bear markets unless there is a tax-cutting Chancellor in power.
Here is another trend worth thinking about that popped up a few days later in the second-half of May.
As of Wednesday, May 24 shares had fallen by over one per cent in five out of nine previous days. The total nine-day drop (up days included) was almost five percent.
There were 115 other similar occasions in the last 50 years with a host of big drops in a nine-day period. History teaches that a bear market was running in 103 of those occasions.
The tumultuous year of 1975 accounted for nine of the 12 exceptions to the rule. Older investors will recall that high volatility in 1975 came at the end of a massive three-year long bear market during a period of poor economic conditions and very high inflation. Today's economic and stock market conditions are much different.
Aside from 1975, there were 106 similar periods in the last 50 years and a bear market was in place in 104 of those years.
Historical signals like these have worrying implications. If the past is any guide, a sudden burst of positive economic news or a surprise programme of tax cuts could change the underlying trend. Barring these developments, history hints of low odds for any rapid stock market improvement in the next few months.
To sign up for an email alert when a new Expert Commentator article appears click here.