As noted in Part 1, historically, blow-patterns in stock markets share many characteristics. One of them is a shifting monetary backdrop, which becomes more hostile just as prices begin to rise at an accelerated pace, the other is the psychological backdrop to the move, which entails growing pressure on the remaining skeptics and helps investors to rationalize their exposure to overvalued markets. In addition to this, the chart patterns of stock indexes before and after blow-off moves are displaying noteworthy similarities as well.
“On Margin” – a late 1929 cartoon illustrating the widespread obsession with the stock market at the time. There was just a 10% margin requirement, i.e., investors could leverage their capital at a ratio of 10:1. The demand for margin credit was so strong, that it pushed call money lending rates in New York up quite noticeably. This in turn made it increasingly difficult to maintain extremely leveraged positions.
Why do we assume the current move is a speculative blow-off and not just another “normal” up-leg? The main reasons are the speed and size of the move, the fact that it happens at the tail end of a very sizable advance that has already lasted a full eight years, the chart pattern, and above all, valuations.
The chart below was recently posted by John Hussman – it shows the evolution of five different valuation parameters over the entire post WW2 era. As an aside to this: he estimates that another 12% advance would push SPX valuations to the extremes recorded in 2000. We already seem to have passed the 1929 threshold recently, so this is the only record that remains to be aimed for (that does not mean one should expect it to be reached).
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