The long-term trend of the market is up, and always has been, according to this century-plus chart. Looking for signs of a stock market top from the thousand-foot level would be difficult.
But within that long-term uptrend are periods of bull-market strength—like 2017—and periods of bear-market weakness—like the very difficult stretch that occurred during the height of the pandemic and the grinding bear market of 2022.
If you can avoid those punishing bear markets, ideally, by selling your riskiest stocks and raising cash soon after the market tops, your results can beat the averages—easily.
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But how do you identify a stock market top?
There’s no perfect system; if there were, everyone would use it. But over the decades, we at Cabot have evolved a dependable set of criteria that’s been a big factor in helping us steer our readers to safety when risk grows.
In this column, I discuss five signs of a stock market top, starting with those signs that generally come first and ending with the one that usually comes last. Equally important, for each indicator, I tell you where we are now.
Stock Market Top Sign #1: Narrowing Market Breadth
The healthiest market is one in which the majority of stocks are participating. But as bull markets fade, participation tends to narrow, as lower quality stocks are left behind and investors increasingly focus on the highest quality performers.
At Cabot, we have two ways to measure breadth when looking for a stock market top.
The first is the Advance-Decline Line, which is simply a running daily total of the number of stocks on the NYSE that advance less the number of stocks that decline. In a healthy bull market, the Advance-Decline Line regularly hits new highs. But as the bull market ages, the A-D Line fails to keep up with the leading averages. That’s called a divergence—and we’re not seeing that on the NYSE today (although we have been seeing that in the Nasdaq).
The second way we measure breadth—and this is only relevant to picking market tops—is to monitor the number of stocks on the NYSE hitting new lows (Cabot Growth Investor’s 2-Second Indicator). When the number is greater than 40 while the major indexes are rising to new peaks, it’s a danger sign. Right now, this is clearly negative, with 20 of the past 24 trading days bringing greater than 40 new lows—even as the S&P and Nasdaq remain near new high ground.
Stock Market Top Sign #2: Increased Bullishness
Because the market tends to lead the economy, the economy tends to be healthier in an older bull market.
A mature bull market is one in which most investors have profits, and thus it makes sense that they feel more optimistic as the bull market progresses. One way to measure bullishness is to count the number of bulls and bears among professional and amateur investors. The American Association of Individual Investors is net bullish now, although far from the highs, and most retail surveys are closer to neutral.
Stock Market Top Sign #3: Increasing Love For Popular Stocks
In every bull market, there are popular stocks that everyone wants to own.
In recent years, the so-called FAANGs – Meta (META), Amazon (AMZN), Apple (AAPL), Netflix (NFLX), Alphabet (GOOG) – were among the most popular. Those were usurped by the Magnificient Seven stocks. And then the Magnificent Seven stocks were whittled down to just a handful, with Nvidia (NVDA) clearly dominating investor interest.
Conclusion: the emergence of NVDA is likely enough to count as a warning of a market top.
Note: The first three indicators above tend to precede market tops. The next two below are trend-following indicators.
Stock Market Top Sign #4: Cabot Tides
Cabot Tides is made up of five different major market indexes that help us determine the overall intermediate-term direction of the stock market. They are: S&P 500, NYSE Composite, Nasdaq Composite, S&P 600 SmallCap and the S&P MidCap 400.
The market is considered to be advancing on an intermediate-term basis if at least three of these five indexes are advancing. Contrarily, the market is deemed to be declining if at least three of these five are declining.
To derive intermediate-term signals, we compare each index to its own 25-day and 50-day moving averages. If the index is above the lower of these two moving averages, and that lower moving average is itself advancing, then the index is bullish. Otherwise, the intermediate-term trend for the index is bearish.
Right now, three of the five indexes we track continue to meander within multi-month ranges, which keeps the Cabot Tides on the fence. We have seen a little bit of outperformance among some growth indexes, which is a ray of light, but at day’s end, few sectors or indexes are in sustained intermediate-term moves.
Stock Market Top Sign #5: Cabot Trend Lines
The Cabot Trend Lines monitors the 35-week moving averages of both the S&P 500 and the Nasdaq Composite to determine the long-term trend of the market.
If both indexes close two straight weeks above their respective 35-week lines, the indicator is positive; if both close two straight weeks below them, the indicator is negative. This indicator is generally the last of the five indicators to speak, and when it does, you should pay attention.
Right now, the Cabot Trend Lines are clearly bullish.
Conclusion About Identifying A Stock Market Top
This probably won’t come as much of a surprise if you’ve been following the markets this year, but we’re seeing plenty of mixed signals.
On the one hand, market breadth is poor and much of the progress this year has been driven by NVDA and AI-related names. On the other hand, although the Trend Lines are the slowest to speak, they’re also the loudest, and they show a continuing bull market.
Add in the indeterminate signal of the Tides, and we’re seeing a market that is showing signs of fatigue more than exuberance, a yellow flag if you will. For the time being, it pays to remain invested and pick your spots.
If you’d like our help identifying a stock market top, through regular updates on our top market timing indicators, you can get them each week in Mike Cintolo’s Cabot Growth Investor.
To learn more, click here.
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*This post is periodically updated to reflect current market conditions.
