The Crocodile Will Soon Snap — When Divergences Warn of Market Turning Points
August 19, 2025
10 min read
The Crocodile Will Soon Snap — When Divergences Warn of Market Turning Points
Textbook warning signs: divergences stack up, valuations are stretched, the crocodile's jaws are wide open. History says they won't stay that way for long — and investors must choose a side. Our original analysis for The Market by NZZ — plus the extended investor's view for arvy readers.
The thesis on video — 1 minute
In 30 seconds — the core thesis
- Healthy markets confirm their trends — price increases + broad market participation + momentum + seasonal patterns all pull in the same direction. When price races ahead and indicators stall, a divergence emerges.
- The crocodile's jaws are the analogy: a growing gap between price (top) and fundamental indicators (bottom). Historically the gap closes — usually not by indicators catching up, but by price giving in.
- In August 2025 the divergences stacked up — Dow Theory confirmation was missing, market breadth narrowed, valuations were stretched. That's not a guarantee of a correction, but an asymmetric risk-reward constellation.
The original analysis — the opening
Divergences.
In investing, that's not a word you want to hear.
Why? Healthy markets confirm their trends. We want a bull market backed by broad participation and classic indicators: breadth (how many stocks are rising), momentum, and seasonal patterns. When price races ahead while those indicators stall, we don't get confirmation; we get a divergence — a disconnect between price and the underlying engine that usually powers it.
That's where we are in mid-August: red flags popping up across several well-watched gauges.
What usually happens in such a setup is best captured by the crocodile analogy: the market opens its jaws wide, just like the prehistoric predator. And then, with high probability — or to put it in investor terms, with an unattractive risk/reward — the gap between the upper and lower jaw has to close. That can happen in two ways:
- The «outperforming» side pulls back,
- or the «underperforming» side rallies to catch up.
But here's the twist: in nature, crocodiles can only close their jaws from the top down. And in markets, when the gap is wide and risk/reward looks poor, history suggests the easier path is usually down, too.
And that's why, given today's market setup, the odds say just one thing: The crocodile — a.k.a. the market — is about to snap.
→ Read the full article with the Dow Theory analysis on The Market by NZZ
Chart 1: S&P 500 and Dow Jones Transportation — the divergence
Source: NZZ The Market
01The uncomfortable question: what does this mean for your portfolio — today and in any similar constellation?
If you're reading this article in April 2026 or in two years, the specific August 2025 setup has long since either confirmed itself or dissolved. What matters — and what doesn't fit into an NZZ column with depth — is not the individual case but the recurring mechanism: divergences are a classic early warning system that will be relevant again in any similar constellation in the coming decades.
The uncomfortable question isn't "will the crocodile snap now?" — nobody can time that with certainty. The more important question is: what does a disciplined investor do when indicators show multiple warning signals simultaneously? This question is timeless and belongs to the standard toolkit of every serious investor. It will be just as important in ten years as it is today.
Three answers that are almost always wrong:
- "I'll sell everything and go to cash." That would be market timing — and market timing fails in 80–90% of cases, even for professional investors. You'll either be out too early and miss the last wave, or out too late and already in drawdown.
- "I'll ignore the warning signs, the market will keep rising anyway." That would be recency bias — the assumption that the recent past is the best forecast of the future. Classic in late bull-market phases, classically expensive.
- "I'll buy puts and short the market." Hedging and shorting have costs and their own timing problem. For most retail investors it's expensive insurance that gets renewed or closed at the wrong time.
The right answer is more boring
The honest answer: in such constellations a disciplined investor doesn't reduce engagement, but shifts the quality of engagement. More quality compounders with defensive cash generation, fewer hypergrowth stories with stretched valuations. More robust business models, fewer fragile narratives. That's risk management through selection, not through timing. Over 20 years this discipline makes the decisive difference.
02What divergences actually signal — the mechanics behind
Divergences are not a single mystical signal. They are a class of early warning indicators that all share the same basic principle: when the price of a market diverges from the fundamental drivers, the system is fragile. Four concrete divergence types every investor should know — not to time them, but to recognise them when they appear together:
Divergence Type 1
Market breadth
Index rises but fewer and fewer stocks carry the rise. When the S&P 500 makes new highs but only 30% of single stocks participate, the foundation is narrow.
Divergence Type 2
Sector confirmation (Dow Theory)
Over 100-year-old doctrine: sustainable bull markets are confirmed by transport and industrial sectors. When the broad market rises but transports stagnate, the economic reality behind it is missing.
Divergence Type 3
Volume vs. price
Price increases on declining volume are less credible than on increasing volume. Classic indicator of waning buyer engagement.
Divergence Type 4
Fundamental valuation vs. price
When earnings stagnate or fall but prices rise, valuation multiples expand — a fragile form of outperformance.
Single divergences are common and often lead to nothing. What historical experience shows: when three or more divergence types appear simultaneously, the probability of a correction in the following 6–12 months is significantly elevated. That's not a guarantee — and timing remains impossibly precise. But the asymmetric risk-reward constellation shifts measurably.
The crocodile asymmetry
Thierry's crocodile analogy shows an important asymmetry: in nature, crocodiles close their jaws only top-down — the lower jaw is fixed. Translated to markets: when a gap emerges between price and fundamentals, it's significantly more likely that the "outperforming" price side gives in than that "underperforming" fundamentals suddenly catch up. This asymmetry is the actual reason why stretched valuations in late-cycle phases trigger painful corrections.
03What this means for your quality portfolio
The beauty of a divergence analysis is that for quality investors it doesn't have to become an apocalypse discussion. Quality strategies have structurally built-in protection mechanisms against exactly these market phases. Three mechanisms that become particularly valuable in divergence constellations:
| Quality mechanism | Why it protects in divergences |
|---|---|
| Reasonable valuations | Quality compounders typically don't trade at hypergrowth multiples. When the multiple reset comes, the fall height is significantly lower. |
| Structural cash generation | Even in corrections quality businesses deliver stable cash flows. The business keeps working even if the stock price swings. |
| Defensive sector characteristics | Many quality champions operate in sectors with inelastic demand (consumer staples, healthcare, utilities). Even in recessions people keep buying food and medicine. |
That doesn't mean quality stocks don't fall in a correction — they do. But typically significantly less than hypergrowth, and they recover structurally faster. Over full market cycles — meaning bull markets plus the following corrections — quality strategies historically outperform consistently. Exactly this cycle effect is what makes quality investing the superior long-term strategy.
Concrete implications for various investor types in a divergence constellation:
| Investor profile | What divergence signals mean | What to review |
|---|---|---|
| Hypergrowth-concentrated | Highest risk in crocodile snap | Consider gradual quality rebalancing |
| Broadly indexed (MSCI World) | Medium risk, due to mega-cap tilt | Quality tilt admixture as strategic position |
| Quality compounders | Low relative risk, drawdown likely but moderate | Hold discipline, strategically buy in correction |
| Cash-heavy / defensive | Low drawdown risk, but opportunity costs if bull case materialises | Gradual quality build-up in corrections |
How quality across full market cycles — bulls, bears, and everything in between — is historically the most reliable strategy for long-term wealth building, is deepened in our pillar article The Tortoise Problem: Why Quality Wins. How disciplined investors navigate turbulent market phases is described in our pillar on crises, wars, and corrections.
04Three scenarios — when the crocodile snaps
In August 2025 three plausible paths stood before the market. History will show which one prevailed — but the scenario logic remains relevant for any similar constellation in the future:
Bull Case
The divergence resolves upward — the market structurally catches up
The lagging indicators (market breadth, transports, smaller stocks) begin to turn. The bull market narrative broadens. The divergence is resolved by real economic strength, not by correction. In this scenario defensively positioned investors miss part of the wave — but quality champions continue to deliver solid returns, simply less spectacularly than hypergrowth. Statistically the rarer scenario in such constellations.
Base Case
Correction 10-15%, sharp differentiation within the market
The typical resolution: a moderate market correction over 3-6 months. Hypergrowth stocks give back disproportionately much (20-30%), quality compounders fall with it but moderately (10-15%), defensively positioned investors hold relatively stable. After the correction the market differentiates sharply — quality champions recover first and lead the next market phase. Our base case for most divergence constellations.
Bear Case
Full valuation cleanup, 20-35% market correction
The divergence resolves not moderately but dramatically — possibly triggered by an external shock (recession, geopolitical event, liquidity crisis). Hypergrowth stocks lose 40-60%, broad indices 25-35%, even quality falls 15-25%. But quality businesses keep paying dividends and compound operationally — and come back first in the recovery phase. Investors without quality engagement have historically had the longest recovery phases in such scenarios.
How disciplined investors navigate exactly these correction phases — and why psychological discipline in drawdowns decides long-term performance — is described in our pillar "Master Your Emotions When Investing".
05What you should review now
Even if this article is read in April 2026 or later — the exercise is the same. Whenever divergence signals stack up (and that will happen multiple times in the next 30 years), this self-assessment is the most valuable thing you can do:
1. Drawdown test of your portfolio. What would happen to your portfolio if the market corrected 25% in the next 6 months? Which part would be particularly vulnerable? Which positions would presumably suffer most? This honest inventory is more important than any market forecast.
2. Quality share check. What percentage of your portfolio is in real quality compounders (cf. the five criteria from our quality companion)? For most retail investors this number is lower than thought. In divergence phases it becomes the decisive defence line.
3. Cash reserve strategy. Do you have a conscious cash reserve for strategic purchases in a correction? Disciplined investors typically have 5-15% cash that gets gradually invested in quality champions at reasonable valuations during strong corrections. That's not market timing — that's risk-reward optimisation.
4. Psychology check. If the market loses 20% tomorrow, what do you do? Do you panic-sell? Hold iron-handed? Buy strategically? The honest answer decides whether your strategy can work at all. Anyone systematically selling in drawdowns is structurally wrong-positioned — regardless of asset class.
What disciplined investors do now
They don't panic-sell their positions because of a crocodile warning — that would be market timing with all its weaknesses. They review their allocation for structural robustness, gradually strengthen quality positions when the gap is unattractive, hold a conscious cash reserve for opportunities, and above all: they prepare psychologically for drawdowns. Anyone who has emotionally foreseen and accepted a 25% drawdown holds through the real correction with a calm that other investors cannot muster. That's the actual advantage — not better market timing, but better psychological preparation.
06Frequently asked questions
Do crocodile warning signals actually work, or is it apophenia?
A legitimately sceptical question. Academic studies show: single technical indicators often have no consistent predictive power — many "work" retrospectively, fail in real application. What's statistically more robust: convergence of multiple independent indicators. When market breadth, sector confirmation, volume trends, and valuation measures all diverge simultaneously, correction probability rises measurably. Ignoring single divergences — okay. Ignoring four simultaneously — risky.
Did the crocodile actually snap in August 2025?
You can match this article against date and market course — history writes itself. But what we can see retrospectively in any market course: the methodology remains right, regardless of whether the specific turning point in a divergence constellation occurred or was delayed. False alarms occur — but if the signal is right, the correction is significant. Recognising asymmetric risk-reward is not "market timing" but risk management.
Should I build cash before possible corrections?
Generically no, because "building cash before possible corrections" is exactly market timing and costs long-term performance. Specifically yes if you had 0% cash anyway and want to build a reserve for strategic opportunities. The right cash quota depends on investor personality, horizon, and liquidity needs — and shouldn't fluctuate dramatically by market phase. 5–15% cash as strategic opportunity reserve is a reasonable floor for many long-term oriented investors.
How is arvy positioned in this phase?
arvy holds a consistent quality strategy through market phases — we don't try to time corrections but ensure the portfolio is structurally robust through every phase. Concrete sector and single-stock allocations are communicated transparently every quarter. The current state including all adjustments since the start of the year is in the arvy Q1 2026 Quarterly Report.
Further reading — the thematic anchors of this analysis
The Tortoise Problem
Quality as structural defence line in corrections
Investing in Turbulent Times
Discipline through full market cycles
Master Your Emotions When Investing
Psychological discipline in drawdowns
arvy Quarterly Report Q1 2026
Current allocation transparently documented
Trees Don't Grow to the Sky
Why hypergrowth falls particularly hard in corrections
Investing with arvy: The Complete Guide
How this analysis fits the overall strategy
The crocodile is not the enemy — ignorance is
Crocodile constellations are not the end of the world. They are a normal part of market cycles — and they will appear again multiple times in the next ten years. What separates the disciplined investor from the panicked retail investor is not that one can predict corrections and the other cannot. It is that one has structurally built their portfolio so they don't have to fear corrections — while the other emotionally fails at every drawdown phase because they were structurally too fragile-positioned.
The crocodile snaps from time to time. History shows this again and again. But anyone engaged in quality compounders, with a conscious allocation, who knows and accepts their psychological drawdown limits — can live with crocodiles. They are part of the investment landscape, not an existential threat scenario. Exactly this calm, prepared posture is the actual investment advantage. Not the better timing — the better preparation.
Original written by Thierry Borgeat, Co-Founder of arvy, for The Market by NZZ. The extended arvy companion piece reviewed by Patrick Rissi, CFA and Florian Jauch, CFA. Data sources: NZZ The Market, own analyses, Dow Theory (Charles Dow, 1900–1902). Last updated: April 2026.
Disclaimer: This article is for general educational purposes and does not constitute personal investment advice. The market and indicator designations mentioned are illustrative and not buy or sell recommendations. Past performance is no guarantee of future results. Scenarios are assessments, not forecasts. arvy is a FINMA-supervised asset manager with a CISA licence (Art. 24). Imprint & Legal Notice.
