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Stock Market: Be Careful Now

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stock market bear

2014 is no party for stock market investors. January was a smack in the face, especially newcomers, as the markets decided to go for a 5 percent nosedive. But they again recovered in February and some indices put up new all-time highs; others are on the fence and you can feel that doubt is creeping in as investors are starting to feel uncomfortable having a large part of their portfolio invested. As a result, March also turns out to be a challenging month for stocks. And this should not come as a surprise, as different signals indicate that the market situation is getting overheated.

We cannot blame anyone here. The current bull market has recently had its fifth birthday and is almost breaking the top 3 of the longest stock market rallies in history. With an increase of 147% for the Dow Jones index from its March 2009 low, it is obvious that the magnitude and momentum of this bull market is just as qualified for the history books as its duration. That is clearly visible on the next chart (source: Barclays).

Bull markets - duration vs magnitude

You can also see that we have seen better and longer bull markets in the past. In the ‘50s, we had a seven year bull market and the bull market of the ‘90s lasted for almost ten years! Just to be clear: a bull market remains theoretically intact as long as an index does not drop by more than 20 percent from a high. There is plenty of upside in other words, but the air does get thinner the higher we go. Naturally, the upward potential has decreased and as history has taught us, at one point the cable on this elevator will snap and we will go down a lot faster than we came up.

The question, of course, is when will the music stop? That has always been a tough call to make. With regards to valuation, we are already in overtime at the moment. The markets are generously valued at this point, more specifically when looking at market capitalization versus GDP (Warren Buffett’s favorite indicator). Another comparable ratio, however, is also showing warning signs. The Tobin Q ratio measures the total market cap of non-financial listed companies in relation to the replacement value of the assets of these companies. The ratio is a good check to see if the fair value of these companies is deviating from their stock price. Above 1x, this ratio indicates that investors are prepared to pay a lot more for expected performance and goodwill.

Tobin Q

The above chart from Ed Yardini clearly shows that the actual position of the Tobin Q ratio, as well as the adjusted version, has been living north of the 1x level since the fourth quarter of 2013. In the past, namely in the seventies, the current position would have been enough to cause turmoil. Naturally, there are exceptions as evidenced by spike around the dot com boom, but still…

Still, it feels like the 2000-period on the stock market. Just have a look at the chart below, which compares the S&P 500 to the Rydex Asset Ratio (Bears versus Bulls). It’s been 13 years since the ratio dropped this low. Investors are pouring massive amounts of cash into equity funds (long only) and liquidating their short / hedge funds and money market funds. This again is huge warning sign for the markets.

Rydex Asset Ratio 2014

And that is precisely the problem investors have today. On the one hand, valuation and duration are above average, but that does not necessarily mean that we are at the dawn of a big stock market correction. This stock market rally could last for a few more years and valuations have a lot more room to grow before we can even start talking about a bubble. On the other hand, it is clear that the rally is having a tough time repeating its 2013 performance, at least for now.

That is why vigilance is in order. Indeed, investing is making an estimation regarding the future, taking healthy probabilities into account. As the market rally persists, its effective life span decreases; that is pure logic. Unfortunately, logic is not always what governs the stock market. Nevertheless we have become more careful in 2014 and have advised our subscribers to take profits of the table here and there, without getting out of the market completely. We rather wait and see for now as things could go either way from this point.

Protect your capital: read our GUIDE TO GOLD!

 

Sprout Money offers a fresh look at investing. We analyze long lasting cycles, coupled with a collection of strategic investments and concrete tips for different types of assets. The methods and strategies from Sprout Money are transformed into the Gold & Silver Report and the Technology Report.

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Sun, 03/16/2014 - 15:37 | 4555808 Philalethian
Philalethian's picture

Here is an interesting report on the crashing dollar.

http://www.youtube.com/watch?v=lCcea8Ui2yo

Sun, 03/16/2014 - 14:16 | 4555471 ebworthen
ebworthen's picture

Lots of hot air in that bubble.

What a huge ball of spun cotton candy with FED sugar.

Too bad generations of Americans have their savings trapped in 401K's/I.R.A.'s/Pensions.

It's almost as if it was planned that way.

Sun, 03/16/2014 - 14:13 | 4555455 Comte d'herblay
Comte d'herblay's picture

J T B T M Fing D!!!

 

 

Sun, 03/16/2014 - 13:34 | 4555281 moneybots
moneybots's picture

"The Tobin Q ratio measures the total market cap of non-financial listed companies in relation to the replacement value of the assets of these companies. The ratio is a good check to see if the fair value of these companies is deviating from their stock price."

 

What is the fair value, once the rampant financial fraud is deducted?

Sun, 03/16/2014 - 13:30 | 4555256 moneybots
moneybots's picture

"The markets are generously valued at this point, more specifically when looking at market capitalization versus GDP (Warren Buffett’s favorite indicator)."

 

In stead of looking at it in terms of GDP, how over valued is it in terms of financial fraud?  Fraud is just as rampant as it was before 2008, yet the market is higher.

 

Sun, 03/16/2014 - 12:47 | 4555092 shankster
shankster's picture

Everything is OK...just have another brewski lay on the couch with a bag of chips & turn on the ball game.

Sun, 03/16/2014 - 12:44 | 4555077 g'kar
g'kar's picture

I still hear the FED pumps running. Kachunk, Kachunk, Kachunk

Sun, 03/16/2014 - 12:40 | 4555062 AdvancingTime
AdvancingTime's picture

For some time I have been trying to develop a scenario for a market crash and a reasonable map to such a situation. We have never recovered from the Great Recession. By printing money, imploding interest rates, and exploding the Federal Governments deficit we have only delayed the "big one".

Most investors think that even if things go downhill fast that they will get out of the markets. But what if it hits like the flash crash on steroids? We know that can't happen because circuit breakers have been put in place to arrest panic style moves, but imagine a market that falls, trade is halted, and the market simply does not reopen for days, or even weeks. More on why it may be different this time in the article below,

http://brucewilds.blogspot.com/2013/01/flash-crash-on-steroids.html

Sun, 03/16/2014 - 12:40 | 4555058 I am Jobe
I am Jobe's picture

What about IPHONE  Apps, will that be around is all Sheeples want to know.

Long on Hookers and Pimps bitchezzaz. Ain;t Amerika Great, waiting for HS Teachers to be at the local strip clubs for extra cash along with single moms. The future is bright for such a so called greatest nation on earth

Sun, 03/16/2014 - 12:22 | 4554999 Conax
Conax's picture

When it finally collapses into a heap of failure, and drops about 40%, it should rightly be called a 'correction'.

That's what they call it when it's done to the precious.

What goes around..

Sun, 03/16/2014 - 12:20 | 4554989 poldark
poldark's picture

This bull market can go on for several more years.

So everything is fine then.

Sun, 03/16/2014 - 17:42 | 4556235 pitz
pitz's picture

bullshit market, perhaps. 

Sun, 03/16/2014 - 11:29 | 4554837 DirkDiggler11
DirkDiggler11's picture

I typically agree with Eric Sprott and commentary out of his firm, but this update is complete BS. What here is any new information ? The market appears "toppy"? No shit. The close of the letter is crap as well. Take some profits on some stocks, but stay invested as well. Sure, you can get out of the market through the tiny exit door faster than the HFT algos. Give me a fucking break.

Sun, 03/16/2014 - 14:34 | 4555573 pitz
pitz's picture

This isn't Eric Sprott.  Its "Sprout Money".  You can be forgiven for mistaking the two. 

Sun, 03/16/2014 - 10:16 | 4554612 Racer
Racer's picture

It isn't a 'market' any longer, comparisons are irrelevant to computers who have different programming

Sun, 03/16/2014 - 10:54 | 4554732 Beam Me Up Scotty
Beam Me Up Scotty's picture

Exactly. They have taken full control of the printing press, both of physical dollars and virtual dollars. With the ability to infinitely print money, they can control any market or any stock they choose, either up or down. How do we know the Fed is only expanding the monetary base by only 75 billion a month? Because they say so? For all we know they could already be printing a trillion a month, and giving it all to their buddies.

Sun, 03/16/2014 - 10:06 | 4554595 lordbyroniv
lordbyroniv's picture

4th Turning Bitchez !!!!!!!!!1111

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