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This Graph Shows Why the Stock Market Is About to Fall off a Cliff

Last Updated March 4, 2021 2:45 PM
Laura Hoy
Last Updated March 4, 2021 2:45 PM
  • The stock market’s chart looks eerily similar to every other bubble of the past.
  • The current rally is the final stage of denial.
  • Only five stocks are driving the market, setting the stage for an epic fall.

The stock market has been unstoppable since its March free fall. The Dow Jones Industrial Average and the S&P 500 are now trading around 15% lower than where they were in February.

stock market crash
Stocks have rebounded sharply from their March lows. |Source: Yahoo Finance 

The collective sigh of relief among traders has been nearly audible over the past few weeks as the rally continued despite worsening economic data and a historic plunge in oil prices. Many called a bottom and jumped back in. But looking at the data from further out shows valuations are unreasonable.

stock market crash
Stock market data over one year show current valuations are where they were last summer when the economy was still delivering strong growth. | Source: Yahoo Finance 

The bulls naively cheering the rally are in good company—stock market crashes in the past have been fueled by similarly optimistic traders. They believed the first dip was merely a correction. But this legless rally is just another red flag pointing to a stock market bubble that’s mid-burst.

Comparing the Current Stock Market to Past Bubbles

Past stock market bubbles have one thing in common: Shape. That’s because, more than anything else, equities are driven by sentiment. Whatever investors are feeling is played out on the trading floor.

Right now, they’re feeling optimistic; they believe valuations are fair. But that’s going to come to an end as the stock market bubble of 2020 reaches its final phase: Captiualtion.

The three most notorious bubbles over the past few decades all follow the same pattern.

First, there’s the stock market crash of 1929 that led to the Great Depression.

stock market crash
The crash that kicked off the Great Depression has a prominent, two-pronged peak. | Source: Yahoo Finance 

Next up is the dot-com bust of the year 2000.

stock market crash
In the year 2000 a similar, double peak emerged as investors unknowingly believed the worst was behind them | Source: Yahoo Finance 

Finally, there’s the bitcoin bubble that burst back in 2018.

stock market crash
In 2018, bitcoin traders similarly tried to shake off an initial plunge before capitulating completely.|Source: Yahoo Finance 

All three follow a distinctly similar pattern that has come to be known by many names but essentially describes the anatomy of a market bubble. 

stock market bubble
All three closely mirror a widely accepted graph that maps out the stages of a market bubble. | Source: Wikipedia 

So far, the current market is tracking this pattern almost exactly. 

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Today’s market looks to be nearing the second peak before capitulation | Source: Yahoo Finance 

And if that is indeed the path the stock market is on, we have yet to face the stages of “Fear,” “Capitulation,” and “Despair” that mark the end of this tumultuous cycle.

You might be looking at these graphs thinking, “we’ve already seen fear and despair, what about the huge drop we saw in March?’ 

The Makings of a Stock Market Bubble

Indeed we did see a massive drop in March as coronavirus spooked the market. But fear doesn’t exactly describe the way investors felt as sharemarkets tumbled. The Fed’s consumer sentiment guide shows that investors were getting more bullish as the economy shut down and the stock market fell. 

stock market crash
Market sentiment data show investors are greedy, not fearful, despite the drop. They were in denial in March. | Source: NY Fed 

Now, investors are trying to convince each other that we’re over the ‘correction’ that happened in March—“onwards and upwards” is their chant. Retail investors are snapping up stocks. “Buy the dip!” is their battle cry.

Meanwhile, the smart money—the big money—is taking profits.

average cash balance
Cash positions are rising as the smart money takes profits. | Source: Bloomberg 

Bank of America’s Fund Manager Survey shows that cash positions among fund managers have risen to 5.9%— their highest in nearly a decade. 

Warren Buffett, a man known for his willingness to buy when the market is down, has been holding tight to his cash pile despite resounding calls that the bottom has passed.

There are other echos of past stock market bubbles that investors are ignoring, too—like the fact that the market is being driven by a handful of tech-heavy hitters.

As coronavirus panic set in, investors flocked to the big-name tech firms perceived as safe—Apple (NASDAQ:AAPL), Amazon (NASDAQ:AMZN), Alphabet (NASDAQ:GOOGL), Facebook (NASDAQ:FB), and Microsoft (NASDAQ:MSFT).

stock market bubble
Only five stocks are driving this market. | Source: YCharts / Irrelevant Investor

Those five companies now represent nearly half of the market’s overall value. If one, or worse all, of the stocks, make a wrong move it’s game over for the market. 

Not everyone sees the stock market taking a nosedive. In fact, many are calling for a quick recovery. But you can add that to the growing stack of evidence pointing to a meltdown—it’s not until the majority of commentary is pointing to further losses that you’ll know it’s safe to start retaking positions. 

Disclaimer: The opinions expressed in this article should not be considered investment advice from CCN.com. As of this writing, Laura Hoy did not hold a position in any of the aforementioned securities.