When it Gets Stupidly Bullish, You’ll Know the Market is in Trouble

Dear Reader,

Ahhh…rampaging bull markets…

You’re damned if you’re in ‘em…and damned if you’re out.

What do I mean by that?

Well, if you’re all in and complacent, you’ll give some (or a lot) of it back. How much depends on how complacent you are.

If you’re out and remorseful, you run the risk of getting FOMO, and piling back in right at the top.

When will it end though? This is the big question, isn’t it? Is the melt-up just getting started? Or is this the final blow off top rally?

No one knows, of course. We can only sift through the clues each day and do our best to work it out.

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Where to look for clues

There are a few key areas where I look for clues.

The main one is the charts. This is ‘the market’. It is the verdict of all those players with money on the line. It isn’t an opinion. It is reality.

Listening to the market is the best thing you can do as an investor or trader. It helps you to keep your own opinion in check.

For example, throughout 2019 I was cautious on the market. I thought stocks had peaked in July. But the charts were telling me otherwise. The market was saying ‘your opinion is wrong’.

You can choose to listen. Or you can choose to listen to your ego.

Right now, markets around the world are unequivocally bullish. US stocks keep making all-time highs. Aussie stocks just broke decisively higher, beating the July 2019 high and the 2007 peak.

The verdict of the market is in. And the verdict is, ‘it’s all good!’ I could show you a dozen charts or more to prove my point. But let’s just go with the broad ASX 200.

A strong breakout to an all-time high is hard to argue with. So I’m not going to argue with it.

But it doesn’t mean you need to stop thinking.

While the market might be in a bullish upward trend, it is probably a lot closer to a top than a bottom.

For starters, valuations are becoming increasingly stretched. From The Australian:

Local stocks marched higher for a fifth consecutive record-breaking session, sending the market price-to-earnings ratio to a record, at more than 18x.’

On the surface, that sounds alarming. A record high PE! Quick, sell!!

But when interest rates are at record lows, it would be strange if the market PE wasn’t near a record high.

Two areas money can flow into

What I mean by that is there are two main areas where money can flow into — the bond market or the stock market.

Falling interest rates translate into lower bond yields. Bond prices move inversely to their yield. So the lower the yield, the higher the price.

How can you compare bonds and stocks?

You can do so crudely by comparing yields. The earnings yield of a stock market is the inverse of the P/E multiple. So a P/E of 18 equates to an earnings yield of 5.5%.

This compares to the yield on a 10-year Aussie government bond of around 1.2%.

So, if you’re just doing a brain dead comparison then sure, equities look cheap. Go out and buy the market.

But serious investors are surely asking: Am I being adequately compensated for being an equity investor at these prices?

For the long-term business owner, the answer is no. But for the short-term money manager (the one with career risk etc) the answer is ‘while the music is playing, you gotta dance’.

The thing is, it’s not clear cut which answer is the correct one. Both are, depending on your timeframe.

So where does that leave us?

Bullish. But understanding that the rapid rise in prices could be taking the market to a major peak.

But judging from another area I focus on, we’re not there yet. This is a little more subjective, but I find it interesting. I’m talking about the sentiment that comes through the pages of the business media.

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When it gets stupidly bullish, you’ll know the market is in trouble. But judging from this sceptical article in The Australian, we’re not at that point:

As investors continued to drive the S&P/ASX 200 higher on Monday, fears the new year rally will fizzle have been highlighted by some of the world’s biggest broking companies, who now openly question the lack of profit growth among our top stocks.

With the ASX coming out of the starting gates this year at a quicker pace than all overseas rivals, JPMorgan has suggested the ASX 200 has “the dubious honour of being the world’s most expensive market”.

The New York broker said that on a range of measures, our sharemarket is over-priced.

Bull markets don’t end in a fit of rationality.

They end when no one cares about being the most expensive market in the world and there being no earnings growth to show for it.

Keep your eyes peeled though, such stupidity could be just around the corner.

Regards,


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Greg Canavan,
Editor, The Rum Rebellion

Greg Canavan approaches the investment world with an ‘ignorance is bliss’ philosophy. In a world where all the information is just a click away at all times, Greg believes we ingest too much of it. As a result, we forget how to think for ourselves, and let other people’s thoughts cloud our own.

Or worse, we only seek out the voices who are confirming our biases and narrowminded views of the truth. Either situation is not ideal. With regards to investing, this makes us follow the masses rather than our own gut instincts.

At The Rum Rebellion, fake news and unethical political persuasion are not in the least bit tolerated. It denounces the heavy amount of government influence which the public accommodates.

Greg will help The Rum Rebellion readers block out all the nonsense and encourage personal responsibility…both in the financial and political world.

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