I’ve lost count of how many times I’ve heard “it’s got to pull back from here, surely”. Meanwhile the tally of record closing (and intraday) highs grows. The Dow has pushed through 23K, the S&P above 2550, the Nasdaq has bettered 6100 and German DAX smashed through 13K. As a group they have registered nearly 175 fresh record highs already this year, a tally that may rise again today. Furthermore, the UK UK Index sits just shy of June’s 7600 record high, showing interest in making another new record itself.

Historical precedents are easily pointed to for pre-crash comparisons of overvaluation, to support the narrative for a correction. But much like the football chant “sing when you’re winning, you only sing when you’re winning”, all we hear from are those saying things have gone too far. Not those riding the trend. Perhaps because the former tried to call the top a while back, now sitting on losing positions, needing a correction to ease the pain. Or they missed the rally and, for fear of the end being just round the corner, don’t dare to buy in now.

“Hope is not a trading strategy”

Interestingly, the ‘markets’ have been at over-egged levels for days, weeks, even months. Longer according to some. In reality, those who missed out probably only want to see a pullback for an opportunity to jump on-board what they hope is the next leg higher of a trend that still has at least some legs. After all, it’s proved costly not being on board. Look how far we’ve come. Remember Dow 20K, 21K, 22K. Remember the DAX at 11K and UK Index at 7100. They can’t all be desperate to trade short and profit from a decline.

Anyway, why does the market ‘have’ to drop? There’s no obligation. It isn’t something tangible that follows orders or crumbles under negative commentary (although it can fall foul of spikes and algorithms). It’s a complex ecosystem of fear, greed and psychology, driven by investor appetite and how much more one party is prepared to pay to own something (that they hope will rise) versus how much someone else is prepared to sell it. If the former is more desperate to own what the latter is selling, he’ll have to offer a higher price. If the latter is more desperate to offload what the former wants to buy, he’ll have to accept a lower price. Until the balance of risk appetite changes, the trend (up or down) can continue.

“Trade what you see, not what you want to see”

When you’re trading fresh high there is no psychological resistance. There’s no vested interest from days gone by. Nobody saying “that’s my break-even level, that’s where I’ll get out”. If there was, we might have had trouble breaking above each and every round number along the way. Have we? Hardly. Yes we have had strong inflows into large cap stocks via ETFs, sending stocks higher, attracting even more ETF money and rinse and repeat, and we have no way of knowing what will happen when this cycle ends. Yes extreme monetary stimulus (neg rates, QE etc) has propped up demand for risk assets. But again, how expensive has it been staying on the side-lines watching and waiting?

I am not for one minute trying to say that this is not the top for the major indices. Nor that this rally will keep going for any given time duration or percentage. I’m merely saying that just because something goes up a lot doesn’t mean that it has to come down imminently. Especially not just because you want it to. If that were the case, investing/trading would be easy. It isn’t. Whichever camp you are in, nobody forced you to call the top early. Nobody obliged you to support a losing position, hoping it’ll come back. Nobody made you hold off and sit on the side-lines.

“The trend is your friend, until the bend at the end”

All I am saying is that next time we see such a phenomenon, rather than trying to beat the market and call the top, allow the trend to show you that it is indeed at or near the end. You can’t make it turn south by shouting at it and telling everyone it’s gone too far. Not unless you have an unbelievably big sway on the markets and everybody takes what you say as Gospel. Like a big bank or fund manager. Otherwise, it can be a rather expensive fight, both in terms of financial loss and/or lost opportunity.

Mike van Dulken, Head of Research, 18 October 2017