The Big Blow-off Before the Big Blow-out?

US stock prices are currently reflecting an exceptionally high level of confidence. Certainly much higher than when we wrote our August 2016 article Stocks Are Breaking the Glass Ceiling: 6 Reasons to be Bullish. Hard evidence of this euphoria comes from the latest preliminary inflation adjusted Shiller P/E, which is a cyclically adjusted price to earnings ratio, commonly known as CAPE. It is currently at a reading of 33.2, which is slightly above the 1929 peak of 32.6. It has never been higher, except for the last 18-months of the tech boom and the subsequent initial drop. To emphasize this point, the shaded areas in Chart 1 show the only period when the P/E and inverted S&P dividend yield have been higher than they are today.

Moreover, in mid-January, Investors Intelligence reported that the spread between bullish and bearish newsletter writers was at its highest level since April 1986. One is certainly justified in concluding that these elevated levels of valuation and optimism offer an unattractive reward/risk ratio. While not disputing the dangers of such extreme readings, we believe that trend is a more important factor, as markets often reach dangerous levels yet still overshoot. It’s also important to bear in mind that sentiment during bull markets is usually a leading indicator. For example, the market did not reach its 1987 peak until seventeen months after the April 1986 extreme reading from Investor’s Intelligence.

Stocks are most vulnerable when optimism is at an extreme and its long-term trend reverses. This is when careless investment decisions are exposed, as well. Right now, the P/E is well above its 48-month MA and secondary up trendline, and is showing no signs of weakness. The sharp drop in early February, is a timely reminder that a downturn could happen at any time of course. Two other “glass ceilings” though, are currently in the process of being cracked and suggest that what is currently risky may soon become more so.

Chart 1 Inflation Adjusted Stocks versus Two Valuation Indicators – 1890 – 2018 (Sources: Reuters, Martin Pring’s Intermarket Review,

The Shiller P/E and inverted dividend yield are close to historic levels but their trend is still up.