Is The Market About To Top Out?

Never invest with the herd. More often than not, it is disastrous for your investments. No one can predict what the market will do; but one of the best indicators of a market top is when a so called perma-bear becomes a bull.

Is a tiger changing his stripes a sign of a market top?

It is certainly one of them. When a famously bearish analyst joins the chorus of bulls, it's time to be a little careful. One of the loudest contrarian voices, James Grant recently jumped ship.

James Grant is the editor of Grant's Interest Rate Observer. Among his books is "The Trouble with Prosperity." He is often referred to as a “perma-bear.” Reporters ring him up when there is a downturn in the markets. A glass half empty kind of guy. His recent article in The Wall Street Journal and newly bullish stance has caused a buzz in the US markets.

The Market Does What It Wants To Do

Sharp rallies are the rule in a bear market, not the exception. It is common for the market to rocket upward in an overall downtrend. Take a look at the following chart of the Dow Jones from 1929 – 1932.

During that time, there were seven major declines and six major rallies. The rallies ranged from 19% to as high as 101%. And in every case, investors probably thought the worst was over and a new bull market had dawned.

This rally has not been built on the foundation of improving fundamentals. There is still too much wrong with the economy to hope that a new bull market is beginning just yet.

What To Do?

Don't sell and exit the market. This rally could run much higher regardless of the fundamentals. Book 50% of your profits, set trailing stop losses and let the rest of your profits ride.

Is Irrational Exuberance Back In The Markets?

With market chaos abating the return of risk appetite in stock and lending markets is logical - up to a point. Markets probably overshot to the downside and some level of recovery is therefore only a return to a sensible middle ground.

But there are clear signs of an overshoot on the upside - an 'echo bubble'. Sensible analysis of stock prices for instance suggests that after the run-up of recent months, markets are clearly overvalued. A recent rash of IPO's (NHPC, Adani Power, Oil India), follow-on offers and QIP's (Axis Bank) and large bond issues can be seen as a return to business as usual.

Investors are also tired of talking about the macro issues. That's understandable given the return of a modicum of stability to markets. Yet the things that keep people awake at night are still the big macro concerns:

• Is the US consumer going to pull back further?
• Is a continuing downturn in commercial property going to undermine the credit recovery?
• Are bad things still lurking in the banking system?

The fact is that the foundations of a recovery are scarcely in place, yet the optimists are already looking for the lift to the new skyscraper's observation deck.