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Is the Worst Really Over?

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Nobel Prize-winning economist Paul Krugman says the world avoided a second Great Depression. Goldman Sachs’ senior strategies Abby Joseph Cohen is convinced that a new bull market has just begun. Without wanting to sound cavalier, where was her call a few months ago?

The recent batch of news hasn’t been good – just less bad than expected. But is it good enough to assume that the worst is really over?

Employers are still slashing jobs, retail sales are disappointing, corporate revenue (despite cost cutting and stimulus packages) is falling, home prices are far from recovering, foreclosures are rising and expected to continue rising; the list goes on.

Standard and Poor’s reported that the S&P 500′s P/E ratio is currently at 143.95. That’s no typo. Based on earnings as reported over the past several weeks, the P/E ratio truly is 143.95. This is the snapshot of the current reality, not a wishful projection.

Prior market bottoms of historic proportions have seen the P/E ratio drop to the single digits. In fact, no prior bear market has been put to rest unless P/E ratios have reached single digits and thereby reset valuations to reflect rock bottom prices.

This clearly shows that stocks are still overvalued, despite the declines seen since the 2007 market top. What is driving the current rally?

As the ETF Profit Strategy Newsletter pointed out on several occasions, investor sentiment is the single most powerful driving force behind stock prices. Stocks are worth as much as investors are willing to pay.

Back in January 2009, with the Dow above 9,000, the newsletter noticed extreme levels of enthusiasm and recommended to sell long positions and load up on short positions. On the flip side, extreme levels of investor pessimism caused the newsletter to recommend closing out short positions and going long on March 2nd, 2009.

Once again, the pendulum has turned. Current sentiment readings are rivaled only by the extreme optimism that surrounded the October 2007 all-time highs. Such heightened levels simply indicate that most investors have moved their money from cash into stocks.

Currently, there are much more owners of stocks than there are potential buyers. This scenario does not bode well for stocks; in facts it’s a near certain sign that lower prices are ahead.

The September issue of the ETF Profit Strategy Newsletter contains an analysis of investor sentiment along with insightful parallels between the Great Depression and today’s bear market. The implications are quite sobering. As usual, the vast majority of investors will be proven wrong once again.


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