Investment Update: Are We at a Market Top?

Jeff Mortimer, CFA, Director of Investment Strategy

The current bull market exhibits little resemblance to historical market highs when examined through a monetary and economic lens.

We’ve all seen this movie before. With equity markets near all-time highs, investors are asking, “Are we at a market top?” Perhaps the short squeeze that recently took place with companies like GameStop and AMC only served to fan the flames of excess. But if we are always fearing that we are at a market top, do we need to take steps to remove this potential “overreaction” from our thinking? Let’s dig into this question about what market tops look like and shed some light on where we may be in this market and economic cycle.

Let me begin by making a provocative statement: In my 30 years of experience, I firmly believe that more money has been lost in opportunity costs in fear of market tops (by prematurely selling or postponing buying) than has been lost in market declines. While calculating opportunity cost versus how much one loses in a bear market is impossible to determine, I offer you this anecdotal evidence. Since I joined BNY Mellon Wealth Management in 2012, the No. 1 question, by far, that I have been asked is: “When will this bull market end?” The S&P 500 has more than doubled during my tenure here.

A Look at Previous Market Tops

As we dig down into the structure of this bull market, we find that this one exhibits little resemblance to historical market highs when looked at through a monetary and economic lens.

History teaches that both economic cycles and market cycles tend to end when the Federal Reserve begins raising interest rates in order to combat higher inflation. But a change in monetary policy doesn’t appear to be on the horizon. At his recent press conference, Federal Reserve Chairman Jerome Powell said, “We’re not even thinking about thinking about raising rates.” During the pandemic, the Fed has also taken steps to stimulate our economy by increasing the size of its balance sheet by approximately $3 trillion, with plans to keep its bond purchasing pace through at least the end of 2021. These actions clearly illustrate that the central bank continues to be incredibly accommodative. The long-trusted mantra of “Don’t fight the Fed” seems to be very good advice for market participants. To say the least, Fed policy is not behaving like it traditionally has at market tops. 

From an economic perspective, it is also hard for me to see a top forming. One of the key metrics I consider an important barometer of economic direction is the unemployment rate. At the beginning of the pandemic, approximately 20 million jobs were lost. About half of those jobs have since been regained through January 2021, but roughly 10 million people are still out of work. While some parts of the labor market face structural changes and may be altered forever, other parts of the market should recover fairly quickly as vaccines make their way through the country and virus restrictions ease. Many people may find themselves getting rehired quickly — maybe not back to their same exact job they lost, but perhaps to a close substitute. This progress in job creation will encourage Americans who have amassed roughly $2.3 trillion in savings during the pandemic to spend, which should bode well for economic growth, corporate earnings and stocks in general.

I often remind people that the pandemic of 1918 was followed by the Roaring Twenties. While I understand the Roaring Twenties was also spurred by the end of World War I, I do believe pent-up demand from the pandemic also drove economic growth higher.

Market Signals

With both monetary and economic backdrops solid, what are markets saying? In my opinion, the stock market deserves much of the credit for its predictive power over the past 11 months. Since the low on March 23, 2020, equity markets have been the first to signal that better days were eventually coming. They seem to be saying the same thing, even today. Let me give you just a few examples. 

One way of measuring market breadth is to look at how many stocks are trading above their 200-day moving average. This average is used as a long-term trend indicator for a stock price, and has a history of being quite useful in determining overall market direction. Exhibit 1 shows what happens to the equity market when 90% of stocks within the S&P 500 index are trading above their long-term trend line. Although many observers would claim that this market is running on borrowed time, history begs to differ. In the past, when 90% of stocks have traded above their 200-day moving average, the future has been bright, with over a 99% chance of markets being higher one year later. The average gain during those time periods was over 8%.

Exhibit 1: +12 Month S&P Performance When >90% Above 200-Day Moving Average

Exhibit 2 looks at a similar phenomenon but from the perspective of sector performance. It shows that a majority of sectors have enjoyed very strong returns over the past five months. When looked at historically, this is the opposite of how markets behave at the top; typically, only one or two sectors exhibit strong performance and most others are poor. This sector chart looked very different back in 1999, for example, with only the technology and communication sectors showing strong return patterns. Thus, comparisons to the late ‘90s do not hold up under this scrutiny as bull markets tend to end with narrow participation from a few, or even only one, sector.

Exhibit 2: Sector Performance

And the stock market has made these strides to new highs with very little overall participation from the “little guy.” In spite of what you hear about the Robinhood crowd, data show that more retail money has flowed into bond funds than equity funds over the past year. In other words, it seems to be the “smart money,” or institutional money, that is already in this market, remains invested in this market and continues to position itself for further gains ahead.


Overall, I am fairly optimistic about the stock market in light of the accommodative monetary backdrop and expectations for a broader reopening of the economy as Americans get vaccinated and progress is made toward a healthier labor market. The equity market’s internal signals are also very positive, with over 90% of stocks above their long-term trend and a majority of sectors showing strong return patterns.

On the other hand, current equity valuations — or the price investors are willing to pay based on 12-month forward earnings — are somewhat elevated. For example, the S&P 500 index is trading at a price/earnings multiple of 21.8x forward 12-month earnings, well above its historical average.  However, in the context of today’s low interest rates and tame inflation, valuations remain reasonable.

While stocks always remain susceptible to a pullback, I continue to believe the path of least resistance remains higher. Of course, we will have to watch inflation, interest rates and investor sentiment for signs of trouble. But my answer to those who ask whether we are at a market top is to stay invested in the market, adhere to a well-thought-out investment plan and enjoy what I believe will be a happy ending to this movie — even for those who cannot help but put their hands over their eyes.

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