Has the Stock Market Peaked? Four Charts Provide Some Clues

stock charts
stock charts

To provide some context for stocks' dizzying drop last week and this week's rapid rebound, I've prepared three "mystery charts" of U.S. equities markets at various points in history.

Can you guess which months and years are displayed in each chart?

Mystery Chart 1 displays the Dow Jones Industrial Average ($INDU) in the period of the great stock market crash of October, 1929, between Sept. 1 and Nov. 25, 1929. The market topped out in mid-October at 358 and fell to 195 in mid-November -- a 45% decline. From that low, the market staged a 28% rally to 250 by late November.

As economist John Kenneth Galbraith noted in his book, The Great Crash of 1929, bullish enthusiasm had overcome previous dips in the market: "Indeed the temporary breaks in the market which preceded the crash were a serious trial for those who had declined fantasy. Early in 1928, in June, in December, and in February and March of 1929, it seemed that the end had come. On various of these occasions The New York Times happily reported the return to reality. And then the market took flight again."

As the market recovered in late 1929, the bullish tone that had underpinned the entire bull market of the 1920s remained firmly in place. Few participants in the 1929 market crash anticipated a depression, let alone the Great Depression. Rather, most saw the market's quick recovery as more evidence that the economy and market were both sound.

Masking Fundamental Problems

Yet, as Galbraith took pains to describe, the U.S. economy and stock market of the 1920s were both plagued by fundamental problems that had been masked by the bull market euphoria.

"There seems little question that in 1929, modifying a famous cliché, the economy was fundamentally unsound," wrote Galbraith. "This is a circumstance of first-rate importance. Many things were wrong, but five weaknesses seem to have had an especially intimate bearing on the ensuing disaster. They are:

  1. The severely uneven distribution of income.

  2. The weak corporate structure.

  3. The troubled banking structure.

  4. The dubious state of the foreign balance.

  5. The poor state of economic intelligence.

"Had the economy been fundamentally sound in 1929, the effect of the great stock market crash might have been small. Alternatively, the shock to confidence and the loss of spending by those who were caught in the market might soon have worn off. But business in 1929 was not sound; on the contrary it was exceedingly fragile. It was vulnerable to the kind of blow it received from Wall Street."

While a case can be made that the U.S. economy currently suffers from these same flaws, the point of Mystery Chart 1 is much more limited: Major market tops are not visible to participants until months or even years after the fact.

Bulls Are Blind to the Top

With that in mind, let's turn to Mystery Chart 2. What period of time does it display?

This chart shows the Dow Jones Industrials from mid-September, 1999, through May, 2000. The Dow topped out above 11,600 on Jan. 14, 2000, and subsequently dipped below 10,000 in Mar., 2000, only to leap back above 11,000 in early April, 2000.

Those of us who were market observers at the time can vividly recall the enduring bullish tenor then. Stock market analysts and pundits continued issuing "strong buys" all the way through 2000 and 2001 as the market slowly slipped toward its October, 2002, lows around 7,200 -- a nearly 40% decline.

Once again, the chart offers no definitive evidence that a multi-year top had been established.

Mystery Chart 3 has one telltale clue:

Yes, that huge one-day decline was last week -- this is a chart of April to May, 2010.

The last chart shows the last three years of the Dow Jones Industrials. Will the market eventually rally back above 14,000? Nobody knows. Only time will reveal if the October, 2007, top above 14,000 was a multi-year high or merely a way station to Dow 15,000.

But what should give bulls pause is the great turbulence visible in the charts of 1929 and 2000 -- and 2010. Major tops are often characterized by wild swings in prices as bulls and bears battle to establish a lasting trend. Discerning tops and trends cannot be done in the heat of the moment. Only time will tell if 11,200 will be a major top or if last week's volatility was merely a brief interruption in a multi-year bull rally.

If volatility continues, that's a clue that a major top may have been established.