Have we just witnessed a ‘blow-off top’ for stock markets?

Market peaks are sometimes characterised by a burst of unsustainable euphoria – a blow-off top, to use a phrase often used in financial circles. We may have witnessed one, according to New Davis Research (NDR).

Stocks tumbled in the first days of December, ending a winning run that had seen the Dow Jones Industrial Average advance 10.5 per cent over a 74-day period. According to NDR’s analysis of previous blow-off tops, such episodes have seen the Dow post median gains of 13.4 per cent over a 61-day period.

The last such occasion occurred in the spring of 2011, when stocks spiked higher before plunging over the following months as the European sovereign debt crisis gripped markets. Autumn 2007 saw a similar burst, before the global financial crisis punctured market optimism, while a similar pattern played out shortly before the dotcom bubble burst in 2000. Today’s high valuations are also a concern, NDR cautioning that “many bull markets have ended with a rally similar to what we have seen since August”.

Of course, there have presumably been instances where large and rapid gains were followed by more of the same. Still, stocks have rallied hard in recent months; some kind of pause or pullback would not be surprising.