Is The Bull Market In The Final Melt-Up Stage?

THE MOST POPULAR TERM ON WALL STREET

Last year Wall Street was overly conservative with what The Wall Street Journal referred to as their "pathetically wrong" 2017 stock market forecasts.  This year the conversation has come full circle, with countless calls for a late-stage bull market 'melt-up'.

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DO THE FACTS ALIGN WITH THE STORY?

Since a 'melt-up' implies a certain degree of irrational behavior that could be followed by a harsh bear-market lesson, it is prudent to see what present-day and historical facts have to say about the seemingly logical melt-up theory.  This week's video presents charts in an objective and unbiased manner, allowing you to draw your own melt-up conclusions.

DO VALUATIONS ALIGN WITH A FINAL MELT-UP?

Recent posts on Shiller's CAPE ratio and standard PE ratios provide some additional insight into the melt-up equation. 

LINK TO POST REFERENCED IN VIDEO

Were Charts Helpful In 2017 And How Can They Help In 2018?  Click here.

History Says Stocks Can Keep Going Up

HISTORICAL PRECEDENT

A common bearish argument making the rounds over the past year goes something like this:

"Stocks have been rising for over eight years; they can't keep going up."

As shown in the NYSE Composite chart below, stocks rallied for eight years off a major low in 1974, broke out to a new all-time high, and then subsequently rallied for an additional 18 years.  In present day, stocks rallied off the 2009 major low and broke out in 2017 making a new all-time high.

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WHAT HAPPENED NEXT?

Given humans tend to extrapolate the recent past into the future, many expect the next major move for the markets in 2018 is a 50%-plus bear market similar to the 2000-2002 and 2007-2009 periods. That is not what happened after the similar historical setup in the early 1980s.  Instead of following the 1964-1980 script, stocks tacked on an additional gain of over 700% (see chart below).

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BUT, WHAT ABOUT VALUATIONS?

If we are to take the "all the charts are meaningless because of valuations" argument seriously, we must convince ourselves that valuations were a useful timing tool between 1964 and the stock market peak in 2000.  

A FAIR AND FACT-BASED ASSESSMENT

In order to make a prudent assessment of the real-world utility of valuations, we must review the information that was available as stocks marched higher between the end of 1982 and 2000.  For example, when stocks broke out to a new all-time high in 1982, the median Shiller PE or CAPE ratio looking backwards (1881-1982) was 14.83. 

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This week's video takes a detailed look at two periods, 1992-2000 and 1956-2000, to evaluate the effectiveness of attempting to use the Shiller PE or CAPE ratio as a market timing tool.  In the video, Shiller PEs are reviewed on stock charts, allowing you to draw your own fact-based conclusions.

To view the video in full screen mode, click the square icon in the lower right corner of the video player.  To exit full screen mode, hit the Esc key (escape). 

LONG-TERM MEANS LONG-TERM

Just as there was normal and sometimes gut-wrenching volatility between 1983 and 2000, even if better than expected outcomes occur over the next 3-20 years, volatility will be part of the equation. 

CAPE: How Helpful Is The Shiller PE?

Shiller's PE is a Different Animal

When a similar question was asked about standard price-earnings ratios in 2017, based on the chart below, it was relatively easy to determine their utility from a market-timing perspective.  In this analysis, we examine the Shiller PE or the Cyclically Adjusted Price Earnings Ratio (CAPE).

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ADDING THE CAPE RATIO TO STOCK CHARTS

Given the level of detail required to perform an analysis of the Shiller PE, it is best accomplished in video form.  Like the standard PE graph above, the video below covers numerous examples of stock market set-ups in the context of the CAPE ratio.  Specifically, the video addresses the following questions:

  1.   What type of environment are we facing in January 2018?
  2.    If we study similar historical environments, was the Shiller PE helpful?
  3.    Does the Shiller PE negate the recent long-term bullish breakouts in stocks?
  4.    Is stock market upside limited by Shiller readings?

Were Charts Helpful In 2017 And How Can They Help In 2018?

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EVIDENCE-BASED INVESTING

The best way to review the effectiveness of evidence-based investing in 2017 is to look back at dated posts from the last thirteen months. The posts below all appeared on Seeking Alpha between December 23, 2016 and December 31, 2017; the dates are links to the original posts:

  1. Secular Stock Market Signals Have Occurred Only One Other Time Since 1928 - Dec. 23, 2016
  2. Are Valuations Similar To Bull Market Peaks Concerning? - Jan. 7, 2017
  3. How Does 2017 Compare To Historical Bubbles? - Jan. 11, 2017
  4. How Was The Collective Mood As Stocks Started A 19-Year Secular Bull Run In 1982? - Jan. 19, 2017
  5. Are Stocks Set Up For A 2011-Like Plunge? - Jan. 23, 2017
  6. Stocks: The View From 30,000 Feet - Jan. 30, 2017
  7. Are The World’s Greatest Value Investors Bearish? - Feb. 6, 2017
  8. How Concerning Is Talk Of Overbought Markets? You Can Decide 1982-2017 - Feb. 22, 2017
  9. Rare Signal Says Stock Rally Is The Real Deal - Feb. 27, 2017
  10. Stocks Post 35-Year Breakout - Mar. 6, 2017
  11. Why Odds Still Favor New Record Highs In Stocks - Apr. 3, 2017
  12. This Indicator Had A Divergence In Both 2000 And 2007; A Divergence Is Also Present In 2017 - Apr. 26, 2017
  13. Are Defensive Assets Waving Red Flags For Stocks? - May 2, 2017
  14. Stocks: The Big Picture - May 16, 2017
  15. Numerous Facts Support Long-Term Bullish Case - May 30, 2017
  16. Low Volatility And Stock Market Risk - Jun. 5, 2017
  17. How Concerning Are Predictions Of A Stock Market Crash? - Jun. 12, 2017
  18. Will Narrow Framing Cause Many To Miss A Generational Rally In Stocks? - Jun. 19, 2017
  19. Are Stocks In A Bubble That Is About To Burst? - Jun. 24, 2017
  20. Is The NASDAQ Showing 2007-Like Cracks? - Jul. 11, 2017
  21. Stocks: The Forest And The Trees - Jul. 24, 2017
  22. These Charts Paint A Long-Term Bullish Picture - Aug. 1, 2017
  23. Is The Market Reacting To Earnings Or Just Charts? - Aug. 7, 2017
  24. Skeptical Bias Toward Stocks Aligns With Bullish Charts - Aug. 14, 2017
  25. How Concerning Are These 7 Bad Signs For Stocks? - Aug. 21,2017
  26. Red Flags Coming From This Breadth Indicator? - Aug. 28, 2017
  27. Why 2017 Looks Nothing Like 1929 Or 1987 - Sept. 28, 2017
  28. Has This Important 2016 Stock Signal Flipped? - Oct. 2, 2017
  29. The Mother Of All Breakouts Still In Play - Oct. 24, 2017
  30. Stock Ownership Figures Look Nothing Like A Bubble - Nov. 7, 2017
  31. Tech Stocks: 2017 Looks Nothing Like 2000 - Nov. 14, 2017
  32. The Big Picture In 3 Charts - Nov. 28, 2017
  33. Fed Rate Hike History Says Bull Could Run For A Long Time - Dec. 14, 2017

100% Bullish Conclusions - No Opinions

The articles above are a sample of evidence-related posts on Seeking Alpha over the past thirteen months. If you review the entire list, you will see 100% of the fact-based posts related to stocks came to bullish conclusions. The posts are not based on personal opinions about valuations, politics, or the state of the U.S. economy; they are based on observable evidence.

Were Charts Helpful In 2017?

The question in the header above is like asking is a golf club helpful in the game of golf? The answer depends on how the golf club is used. Charts, indicators, and ratios are tools that can be used effectively or ineffectively, just like a golf club.

This week’s stock market video looks back at charts presented throughout 2017, allowing us to answer the question, can charts be used as an effective tool in the realm of investing? You can decide after reviewing the video with dated clips. The vast majority of CCM’s weekly videos were included in Seeking Alpha posts in 2017.

Was 100% Of The Evidence Bullish In 2017?

Could we have found bearish charts in 2017? Yes, we can always find bearish charts, indicators, or data sets; the key is to make decisions based on the weight of the evidence. The weight of the evidence was bullish in December 23, 2016 and remained that way until the last article was posted on December 14, 2017.

How Can All This Help Us In 2018?

One of the great things about the financial markets is there are an almost infinite number of ways to attack the risk-reward dragon; our approach is one of many. Under our system, the key to 2018 will be the same as 2017:

  1. Wake up every day and ask are we allocated prudently based on the facts we have in hand?
  2. If the answer is yes, hold “as is”.
  3. If the answer is no, make an incremental adjustment to get the investment allocation back in line with the hard evidence.

This approach allows us to stay fully invested in stocks when the odds are favorable (see 2017); it also gives us an exit/migration strategy for the next inevitable bear market (see 1929-1932, 2000-2002, and 2007-2009).

Real World Example: Evidence-Based Model

The same approach is used to forecast and track hurricanes; an analogy described in Stocks: The Read From Probability Models. The concept of using evidence in the early stages of a bear market to migrate to a defensive posture is outlined in Are Stocks Market Trends Starting To Roll Over?.

 

New Long-Term Equity Breakout

13-Year Consolidation

We have covered numerous long-term bullish breakouts in the equity markets over the past fourteen months. Last week, the ratio of consumer discretionary stocks (XLY) relative to consumer staples (XLP)  broke above an area of resistance that has been in place for 13 years.  When investors are confident about the economy and markets, they tend to prefer consumer discretionary/cyclical stocks over consumer staples.

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Historical Example

Market fractals tell us markets move in similar ways on multiple timeframes (short, intermediate, and long).  After a two-year period of consolidation, the XLY/XLP ratio broke out in 2013, signaling an increasing appetite for economically-sensitive assets.  After we could observe, measure, and record the breakout in 2013, the S&P 500 tacked on an additional 30% (see bottom portion of graph below). 

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Chess Masters, Fighter Pilots, And Stocks

This week's stock market video demonstrates how time-tested strategies leveraged by top chess players and fighter pilots can be used to manage risk and reward in the financial markets. 

A Secondary Breakout

Last week's breakout in the XLY/XLP ratio is a secondary piece of evidence in the bull/bear equation that falls into the "interesting" rather than "critical" category.  All things being equal, we prefer to see a healthy XLY/XLP ratio, but viewed in isolation, it is not a reason to alter our investment allocations in any way; that would also be the case if the recent breakout failed.  

Aligns With Bullish Evidence

If we take a weight-of-the-evidence perspective, the XLY/XLP breakout aligns with the mountain of bullish evidence covered in the past 13 months.