March 31, 2010

Five Reasons the Markets Today Are Like the 2000 Bubble

The bigger the extreme, the bigger the reset to fair valuations.

In many ways, today's market behavior mirrors the final gasps that lead up to the 2000 and particularly the 2007 market top. Here are just a few:

Famed value investor Jeremy Grantham said that riding a bubble is a guilty pleasure totally denied to value managers. Over the past we've seen that the joy of riding a bubble and the subsequent bubble-trouble are tightly connected, at least time-wise.

Surrounding the Nasdaq's (QQQQ) March 2000 peak, the tech-laden index more than doubled and subsequently lost more than half of its value within less than 15 months. In retrospect, many will tell you about exiting bubbles, it's better to be 10 minutes early than 5 minutes too late.
In many ways, today's market behavior mirrors the final gasps that lead up to the 2000 and particularly the 2007 market top.

Here are a few reasons that today's markets resemble those of 2000:

1) The VIX dropped to the lowest level since July 2007

2) The mutual fund cash ratio dropped to the lowest level since August 2007

3) The percentage of bullish advisors rose to the highest level since December 2007

4) Investor's cash allocation dropped to the lowest level since April 2000

5) The percentage of bearish advisors dropped to the lowest level since 19987

Notice the common denominator between all extremes; they haven't been seen since 1987, 2000 or 2007. What does that tell us? A 1987, 2000 or 2007-like decline might be next is a possible conclusion.

But the market is more than just about numbers, it's about emotions. The battle between the fear of losing out on making money and the fear of losing money ultimately drives the market. Those emotions propel the market to extremes. But extremes only last for so long. Stocks always seem to pass through fair value sooner or later. The bigger the extreme, the bigger the reset to fair valuations.

Just a few months ago, P/E ratio rocketed to an all time high of 143 while dividend yields dropped near their all time low around 2 percent. A normal market sees dividend yields around 4 percent and P/E ratios around 20. Bear market bottoms see those levels drop to rock bottom.

What's the conclusion? We haven't seen this bear market bottom simply because valuations went the wrong direction. Just as a car driving in the wrong direction won't see the finish line, valuations moving in the wrong direction won't see a lasting market bottom.

Where is this market bottom? The ETF Profit Strategy Newsletter includes a detailed analysis of four reliable valuation metrics along with a forecast for the ultimate market bottom. Indicative of their implications, the indicators were dubbed the "Four Horsemen" and remind us of the old Wall Street wisdom to start selling when everyone else is buying.
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