Tuesday, July 26, 2011

John Mauldin's Outside the Box: Converging On The Horizon - By Ed Easterling

The end is near! Stock market history and earnings cycle history are converging. As a result, the market is likely to be down for the year 2011 or 2012. If not, then it will have been different this time.

Crestmont’s research focuses primarily on long-term secular stock market cycles and their fundamental drivers. Inside of the secular periods are short-term cyclical cycles, primarily driven by psychology, collective emotion, and reactions to current events. These short-term cycles are part of the market process to incorporate new information and to balance the pressures of buyers and sellers. In the long-run, the short-term cycles are reconciled back to the long-term fundamentals of value.

The stock market remains in a secular bear market. Actually, it is still in the early stages of a secular bear based upon relatively high P/E valuations currently and a relatively low core inflation rate (the driver of P/E over time).

Secular bear markets, albeit fairly flat periods for returns, experience violent interim swings—it’s just the nature of market volatility. Although Crestmont’s research does not explain or predict the short-term movements, it does recognize a fundamental nature and tendency that should be respected. For example, even if we can’t explain why there tends to be short runs of positive years in the market, we should realize that risk increases as we approach the historical limits.

Beware: there are two series of short-term trends that are converging on their limits. They portend increased risk for the stock market (…or new historical precedent). The first is the sequence of market gains and losses; the second is the earnings cycle.

The goals of this discussion are (1) to dispel the notion that P/E is low today and (2) to highlight the risks of a market decline in 2011 or 2012.


Related book: Probable Outcomes