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Sizing Up the Bull Market

The euro/yen ratio can clue you in to market movement


With the Dow Jones Industrials cresting 14,000 this month, it’s a good time to take measure of the current bull market. The advance that began on March 6, 2009 at 3:30 pm ET,   has persisted for 1,434 days. According to Bespoke Investment Group data, it’s now the seventh strongest and eighth longest of all time.  This data tells us two things:

  • There is nothing unusual about the current advance. Seven other bull markets in the past century started at lows where conditions seemed dire, and rose a lot more than we have seen the current market. There is no such thing as a “perfect” bull market or perfect conditions. There must always be fear uncertainty and doubt or stocks would shoot to full value immediately.
  • Second, the ceiling for further advance is still very high in price and far away in time. The bull market that started after the 1987 crash lasted 4,494 days until March 24, 2000, or 3.1x longer than the current bull market. Two other bull cycles were almost twice as long: June 13, 1949 to Aug. 2, 1956 and Oct. 3, 1974 to Nov. 28, 1980. In terms of price, two of the other bull markets produced twice the gains of the current cycle, and one produced gains that were 4x larger.

What Goes Up Doesn’t Have to Go Down Yet

If stocks were expensive, the economy was booming, inflation was rampant, central banks were raising rates and the mood was truly ebullient, we wouldn’t be talking about this kind of upside. But none of those are true. Stocks are cheap (e.g. Apple (NASDAQ:AAPL) at 8.8x forward earnings, GE (NYSE:GE) is 12x, Bank of America (NYSE:BAC) is 9x, Merck (NYSE:MRK) is 11x, Hewlett Packard (NYSE:HPQ) is 5x); GDP growth is a paltry 2% max; inflation is tame due to the slack labor market; central banks are still pumping like crazy; and while the mood has perked up it is nowhere near overly-ebullient.

Bottom line is not to get caught in the mind game of thinking the market has risen so much from its 2009 low that it can’t possibly go higher. Don’t anchor in the past; it’s a classic behavioral economics mistake. The better way to assess the condition is that the market has essentially been flat for five years. Why can’t it go higher if companies are still finding ways to improve earnings via cost-cutting and restructuring; central banks are providing ample liquidity; China is emerging from a recent two-year slowdown; Japan is emerging from a decade-long slowdown; and Europe is still so messed up that it will provide plenty of headlines to knock down sentiment in months to come.

A Correction to Re-Energize the Bull

All that said, a measurable correction probably lies ahead here in February. Nothing huge, just a pullback to around 1,440 to 1,465. That would likely be enough of a pause to refresh bulls and set up the final assault on the highs in the 1,570 area.

What could cause a correction? Other than “exhaustion” of funds put to work by major institutions after a 7% sprint higher in January, the list of suspects would include: a) a renewed threat of sovereign credit meltdown in Spain or Italy, which may already be under way; b) a renewed threat of chaos in the Middle East amid a meltdown of the Syrian regime; c) renewed threat of an attack by Israel on Iran, potentially as a test to new U.S. Secretary of State Kerry; or d)  a slide in Treasury prices due to inflation fears that sends yields flying.

Currencies to Keep an Eye On

I hear what you are thinking. Really, a pullback? Well, volatility has been so low of late that there is a danger of being lulled into a false sense of euphoria.  So I thought I would show you one development you are free to worry about if you like.

One of the most important hidden undercurrents of stock prices is currency differentials. Generally speaking, when global investors take risk, they sell yen and buy euros. This pushes the euro/yen ratio higher.

Click to Enlarge
This can go on for a while without consequence. But ultimately currency differentials tend to reverse on a dime, and then go the opposite direction for a prolonged streak. And the interesting thing is that most (but not all) of these reversals in euro/yen the past 12 years have preceded big declines in U.S. stocks. It happened in 2007, and again in 2008, and most recently in spring 2011, as shown in the chart.

When to Panic, When to Prosper

My sources in the currency-trading world are saying that the recent extreme spike higher in euro/yen since mid-December is probably not sustainable. If it blows off and reverses, risky assets like U.S. stocks may well follow. Some currency trading experts think this could happen as soon as Friday or Monday, but who knows. I’m just saying it is something to watch, and if it tops and reverses, and stocks start to follow, then it won’t be a random coincidence, and you will know to batten down the hatches for at least a few weeks.

If that happens, and it climaxes lower, that event will probably be a great new entry point in stocks like home-builders, media conglomerates, financials, staples and the like that have led the recent rally.

InvestorPlace advisor Jon Markman operates the investment firm Markman Capital Insight. He also writes a daily swing trading newsletter, Trader’s Advantage which aims to capture profits of 15% to 40% and often as much at 100% to 200% in less than 90 days. 

Professional traders and hedge funds make huge profits off volatility.  Now, Jon’s service CounterPoint Options levels the playing field with the first service geared towards helping individual traders make steady, consistent profits with the VIX.  Get more information on Trader’s Advantage and CounterPoint Options today.

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