Courtesy of Doug Short
Note from dshort: MauiPeterB is the persona behind FinancialReckoningDay.blogspot.com. He emailed me the chart at the end of the week, and I’ve reproduced it along with the commentary from his website.
The chart below gives a linear scale comparison of two recent periods of S&P 500 Index history: the BLUE line shows 1981-1995, and the RED line shows 1995-2011. As you can see, the 1995-2011 period has been marked by three stock market bubbles. The first two were followed by violent market crashes, and a third market crash seems inevitable.
The current S&P 500 Index value of 1276 (Friday, Jan. 28th, 2011) is right on the 16-year linear trend line, and the index is repeating, almost perfectly, the market action of 1998-1999: a retracement from 1200 back to 1000, followed by another leg upward toward 1300.
Notice that the 2007 market top (1562) was higher than the 2000 market top (1527), and the 2009 market bottom (683) was lower than the 2002 market bottom (801). Higher tops and lower bottoms indicate increasing volatility, which means if you try to use a market timing technique to identify the market top and get out before everyone else does, you might be in for a disappointment.
In estimating how much longer this bull market has to run, we can ask ourselves if the U.S. economy is stronger and more resilient than it was in 1998-1999? Is the job market stronger? Are career opportunities better? Is the housing market stronger? Is the U.S. dollar stronger? Or is this simply another stock market bubble like the dot-com bubble, driven by the low-interest-rate, easy-money policy of the Federal Reserve, and destined to end in tears and disappointment as the preceding two bubbles ended?
If you buy into the stock market now, your potential gain might be as much as 700 points, if the index goes to 2000, but your potential loss might also be 700 points, if the index falls to 600. That’s not a very good reward for the amount of risk involved. The smart money is saying that given the current over-bought, over-bullish and over-valued market, this is not a good time to be getting into the stock market. But, in the words of Dirty Harry, “Do you feel lucky? Well, do you?”
Postscript: MauiPeterB and I discussed the pros and cons of a liner versus logarithmic vertical axis, and he’s charted the data both ways. The chart above (the one I opted to reproduce) uses the linear scale, which highlights the bubble behavior of the past fifteen years. Below is a log scale version, which gives a better sense of the relative dimensions of the earlier events, for example the Crash of 1987, in the overall scheme of things. Note that the chart below starts at 100 on the vertical axis.
