How to Time the Market

Stocks may finally be topping out.  Or, perhaps, they are just consolidating for their next leg up.  How you see it depends on if you are a bull or a bear.  Here’s a look at recent market action…

After trading flat on Monday the DOW dropped 117 points on Tuesday.  Then, on Wednesday, the DOW was practically flat…up just 7 points.  Yesterday, the DOW picked up 14 more.

Do you see how it works? Stocks go down one day.  Then they go up the next.  Stocks go up one day.  Then they go down the next.  Other times stocks go up, before they go up some more.  Except for when stocks go down, after they’ve already gone down.

If you stare at a stock market index chart over time you can see movements that appear to repeat.  Some market technicians call these waves.  And if you stare long enough you can actually see wave patterns.  When you zoom into a wave pattern you can even see wave patterns within wave patterns.  These wave patterns all appear remarkably predictable…down, up…up, down…just before the moment they change.

Do you get what we are talking about?  What we mean is timing the stock market is a fool’s endeavor.

But occasionally there are those with a knack for predicting major market changes.  Here at the Economic Prism we know exactly how they do it.  In fact, timing these inflection points is actually quite simple.  All it takes is prescient foresight, a lot of practice, and plenty of luck.  With this in mind consider what follows…

What Happened On Four Previous Occasions

Mark Hulbert has been writing the Hulbert Financial Digest since 1980.  In other words, he’s been following stock market movements and writing about them for a long, long time.  And in doing so, he’s come to know a thing or two about how market’s work.

“Here’s a sobering thought as earnings season begins in earnest,” began Hulbert on Tuesday.  “There have been only four other occasions over the last century when equity valuations were as high as they are now, according to a variant of the price-earnings ratio that has a wide following in academic circles.  Stocks on each of those four occasions would soon suffer big declines.”

“According to Shiller’s [Yale University Professor Robert Shiller] website, the CAPE (Cyclically Adjusted Price Earnings ratio) currently is 23.5, or some 43% higher than the CAPE’s long-term historical average.  The four previous occasions over the last 100 years that saw the CAPE as high as they are now:

– The late 1920s, right before the 1929 stock market crash

– The mid-1960s, prior to the 16-year period in which the Dow went nowhere in nominal terms and was decimated in inflation-adjusted terms

– The late 1990s, just prior to the popping of the internet bubble

– The period leading up to the October 2007 stock market high, just prior to the Great Recession and associated credit crunch

“To be sure, a conclusion based on a sample containing just four events cannot be conclusive from a statistical point of view.  Still, it will be hard to argue that the current stock market is undervalued or even fairly valued.”

The Rising and Falling Sea of Liquidity

While it is not certain that the stock market will suffer a big decline this time around.  The proposition that it won’t, is merely wishful thinking.  The odds do not favor it.

Certainly the stock market has weathered all sorts of bad news as of late.  It shook off the mega earthquake, tsunami, and nuclear disaster in Japan like pesky fleas from a dog.  Similarly, compounding revolts and revolutions in the Middle East and North Africa didn’t seem to have much of an impact either.

Obviously there are stronger powers of nature at work…namely QE2…

Despite being an utter failure at boosting the economy, as advertised, QE2 has successfully floated the stock market up on a rising sea of Federal Reserve liquidity.  It’s pushed up the stock market along with most other markets in the face of many corrective forces.  But, alas, QE2 is set to expire in several months.

That’s when the tide of liquidity recedes.  We suspect stock prices will follow.

Sincerely,

MN Gordon
for Economic Prism

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