No matter what Washington or the media claim, bull markets cannot be sustained if the economy is faltering. Neither can a bear market suddenly become a new bull market, with a “V” bottom (media-speak) while economic indicators are getting weaker:
1. The most important indicator that a downturn still has a long way to go is when investor sentiment is still bullish while the underlying economic structure continues to weaken.
2. Price earnings ratios. In recent years, even rational analysts have puzzled over why they no longer seem to “work.” This is all part of the separation of stocks from the values of the companies they represent.
Yale professor Robert Shiller points out that, since 1870, price earnings ratios for big companies have averaged just under 13 for a yield of 7.75%. In late 2001, that ratio was between 25 and 35, for a yield of about 2–4%, depending which biased source you read.
To return to a more traditional price earnings ratio, the DJIA would have to fall to at least 5000.
3. The Federal Reserve. Fed action has been the most closely watched indicator in the last 5 years. But, with the most aggressive rate reductions in history, driving US interest rates down to a level not seen since the 1960s and with no result, it is increasingly clear that when the US economy goes south, there is little government can do to stop it.
4. Consumer and Investor Confidence. There is always an abundance of confidence in the future of business and the market, at peaks. Even after markets turn down, as long as that confidence remains high the bear market has further to go.
Markets traditionally turn around on low volume in the middle of widespread gloom about the future. Those who buy at the very beginning of major bull markets or sell at the beginning of bear markets are regarded as equally unhinged.
5. Gold. In times of uncertainty, the interest in gold and gold shares picks up.
6. Real Estate. It is normal for real estate prices to rise with stock market prices. There is usually a lot of public speculation in real estate at bull market tops. Whether real estate turns down in a bear market depends on how much inflation there is.
In inflationary bear markets, real estate is seen as a haven and prices rise. In bear markets where inflation is low and the currency firm, real estate prices will usually stay firm in the early stages, but will decline as the bear market deepens.
7. Stock market action. At tops, there is what is commonly classified as “churning” (i.e., high volume but not much change in prices, or great irregularity in prices [some up sharply, some down sharply], plus a lot of volatility day to day).
8. Unanimity of bullish forecasts. Business leaders, brokers, advisory services, columnists and broadcasters are, in the main, bullish. Any downturn is dismissed as temporary.
9. Sharp rise in debt. At the top of a bull market, the pervasive mood is that one can make a profit in markets, without risk. Consumer debt, household debt service payments, losses by credit card issuers, bankruptcy filings and mortgage delinquencies all rise sharply.
This list is not complete and, with government playing an ever bigger role in our financial and economic lives, this list changes constantly. But we offer this list to stimulate your own thinking, as an antidote to the pap coming from the media and government trying to convince you that if you just buy and hold, consume like crazy, and put your trust in government, the economy will roll as it did in the 1990s.
We encourage you to be ever mindful of how free markets work, and that the basis of prosperity is responsible citizens willing to assume risk, who never lose sight of the fact that all monetary decisions involve risk. Our system relies on solvent citizens who are self-reliant, not on government’s ability to manipulate interest rates or create “stimulus packages.”
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