The stock market is at a pivotal moment, as it appears to be either nearing a peak or merely pausing before its next upward movement. Whether you view this as an opportune moment or a sign of caution largely depends on your investment perspective—bullish or bearish. Let’s delve into the recent trends and market dynamics.
After a flat performance on Monday, the DOW decreased by 117 points on Tuesday. Wednesday saw minimal change, with the DOW inching up by just 7 points. The upward trend continued on Thursday with a further gain of 14 points.
This fluctuation is characteristic of stock market behavior: one day down, the next day up, and so forth. It can seem like a perpetual cycle where stocks rise, then fall, only to repeat the process. Sometimes, you notice a surge before a bigger rally, or a drop before another decline.
If you closely examine a stock market index chart over time, you’ll likely observe movements that tend to repeat. Market strategists often refer to these as waves. Delving deeper into these wave patterns reveals complex structures that appear surprisingly predictable—down, up… up, down… right before a shift occurs.
Essentially, what we’re highlighting is that predicting stock market timing is an unwise pursuit.
However, there are occasionally individuals with a unique talent for forecasting significant market shifts. Here at the Economic Prism, we understand the method behind this skill. In reality, identifying these pivotal moments requires a blend of intuition, experience, and a bit of luck. With this context, consider the following insights.
What Happened On Four Previous Occasions
Mark Hulbert has been publishing the Hulbert Financial Digest since 1980, and over the years he has developed a keen understanding of stock market trends and fluctuations.
“Here’s a sobering thought as the earnings season accelerates,” Hulbert noted on Tuesday. “In the past century, there have only been four instances when equity valuations peaked as high as they currently stand, based on a well-regarded variant of the price-earnings ratio. Each of those four occasions was followed by significant declines.”
“According to Yale Professor Robert Shiller’s website, the CAPE (Cyclically Adjusted Price Earnings ratio) stands at 23.5, which is approximately 43% above the long-term historical average. The four previous instances where the CAPE reached such heights include:
- The late 1920s, just before the 1929 stock market crash
- The mid-1960s, prior to a stagnant 16-year period where the Dow experienced no nominal growth and significant declines when adjusted for inflation
- The late 1990s, right before the bursting of the internet bubble
- The period leading to the October 2007 stock market peak, before the Great Recession and subsequent credit crunch
“It’s important to note that drawing conclusions from just four events isn’t statistically conclusive. However, it’s difficult to argue that the current stock market isn’t overvalued—or at least not fairly valued.”
The Rising and Falling Sea of Liquidity
While it’s uncertain whether the stock market will experience a notable decline this time, dismissing the possibility is merely wishful thinking. The odds suggest a different outcome.
Recently, the stock market has shown resilience against numerous adverse events. It dismissed natural disasters in Japan as if they were mere nuisances. Similarly, the turmoil in the Middle East and North Africa seemed to have a negligible impact.
Clearly, there are powerful forces at play, particularly the effects of quantitative easing (QE2). Although it has not succeeded in revitalizing the economy as promised, QE2 has buoyed the stock market through an influx of Federal Reserve liquidity. This surge has propelled the stock market, along with various other markets, despite numerous corrective pressures. However, QE2 is set to conclude in a few months.
When that tidal wave of liquidity recedes, we suspect that stock prices will follow suit.
Sincerely,
MN Gordon
for Economic Prism