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Introduction -

There are occurrences in the business cycle when the consensus of my proprietary primary trend indicators find themselves within the confines of the bearish camp. Unfortunately, now seems to be one of those occasions. The last time the technical, economic, and monetary indicators aligned themselves in such a negative way was the turn of the millennium. Then, as now, for the benefit of my subscribers, and their valued clients and investments, I feel duty-bound to publish a Special Report setting out the arguments for the impending scene about to unfold.

In early 2000 it like the market was at, or close to, a secular or very long-term peak (albeit if not in absolute price terms, certainly in inflation-adjusted ones). Since then, the S&P has failed to take out its 2000 high; and deflated for commodity prices, actually came extremely close to a new (secular) bear market low in May of 2006.

Before setting out the current cycle’s negative case though, we must first step back and re-examine the market’s secular, or very long-term, technical position. It’s also important to understand that while the position of the long-term indicators look extremely ominous from a primary trend point of view, they have not been confirmed with a negative 12-month moving average crossover by the S&P. And until that happens, assume the primary uptrend is intact.

At the end of June, the average is expected to be around 1255, which is about where the average was in mid-June when this report was completed. However, it requires a monthly closing price for a signal.

Secular Trend in Stock Prices -

Stock prices have undergone a series of secular up and down trends since the mid-nineteenth century. These very long-term price movements can survive through several business cycles and have often taken the form of strong multi-year bull markets, such as the 1920’s, 1980’s, and 1990’s. On the other hand, secular “bear” markets have been more subdued and often show up on the charts as multi-decade sideways trading ranges. When adjusted for inflation though, these “trading ranges” turn out to be major bear markets where the purchasing value of stocks has been decimated.

Peaks in optimism and troughs of pessimism establish secular inflection points. And what better way to measure this concept than price-earnings ratios? After all, when investors are willing to purchase stocks with a high valuation, they are obviously confident and optimistic. In these situations, prices have typically been moving up for a decade or so, which means that confidence is extremely high and carelessness takes over from sound money management principles. The only reason they literally give them away when valuations are in the basement is because they have little or no hope for the future. Bearing this in mind, Chart 1 shows Robert Shiller’s Price-Earnings Ratio between the late nineteenth century and the turn of the millennium.

Using the P/E Ratio, there have been four peaks in sentiment since 1870. I chose those that developed in excess of 22.5, and labeled them with the numbers 1, 2, 3, and 4. These peaks developed around 1900, 1969, 1966, and 2000, respectively. Generally speaking, when crowd psychology reaches such an extreme (flagged by the high price-earnings numbers), it either takes a long time, considerable price erosion, or both, along with a total disgust with equities before the psychological pendulum can swing sufficiently in the opposite direction to lay the foundation for a new secular bull market. Troughs are signaled when the Ratio falls below 7.5; i.e., at times when the market offered exceptional values (they are labeled A, B, and D). C1 and C2 also offered timely long-term entry points.

Chart 1. See Chart 1A for more detail.

Chart 1A: Showing the comparison between Stock Prices and Shiller's Price Earings Ratio in more detail.