This chart from our friend, Ron Griess at The Chart Store, is a perfect picture of what Ned Davis refers to as a Monster Rally in a Secular Bear Market.
This market has now doubled from “the lows” reached in March 2009. Unnervingly, there have been only two other times when the market has rallied so sharply over this time period. Neither of them occurred during raging bull markets. In fact, both of them occurred during the Secular Bear Market of 1929 to 1942. Over this period, normalized valuations (as measured by CAPE) fell from a peak of 32.6 to a trough of 5.6. While there were occasionally powerful rallies throughout this cycle as evidenced below, investors were well served waiting for lower valuations and/or extreme oversold conditions before dipping their toes in the water.
We find ourselves in a similarly uncomfortable position today, with the markets extremely overbought (below) and still, stubbornly extremely overvalued. In the current Secular Bear Market which began at the turn of the millennium, normalized valuations reached 43.8 – more than 10 points better than the peak of 1929. Even today, after a ten year bear market in stocks, normalized valuations still stand above 24x CAPE, a level significantly higher than any other market peak outside of 1929 and 2000. Coincidentally, today’s Monster Rally (shown below), has taken us back to a similar level of overvaluation reached after the Monster Rally of 1937 (22x CAPE).
The prognosis for forward returns does not look particularly appealing. As shown below, the market’s performance after past Monster Rallies of this magnitude has been decidedly negative 4, 8, 12, 26 and 52 weeks later. It is impossible to know exactly when the fuel will run out of Junk Ben’s Rally, but history has not been kind to those holding on for the last few percent of speculative blow-offs. Be careful out there.