My perspective on "the game"

This is another long read...so buckle up.

First of all, some comments regarding Tuesday's beat down. When the market got whacked a few weeks ago due to Egypt turmoil, the sell-off was a one day wonder which didn't surprise me much. Now we got a sell-off due to Libya and what seems to be growing social unrest in other Northern African and the Middle Eastern countries. So, perhaps this time there will be some follow through especially given torrid run we've had in the market and how oil prices have jumped a lot higher this time. But follow through or not, I'm confident this is a just a correction within a bull market. The loser bears who have been decimaited and humiliated beyond belief for 2 years were celebrating Sunday night on the message boards when the futures were down big and today as well. They are thumping their chests as if the market crashed 50% and they recouped all of their losses. And for what? The market is down 2% after just making a fresh bull market high. These idiots act as if they made millions when even if the market drops 15-20% these bagholders would still be underwater big time. I've seen this behavior over and over since the bull market began and it always gave me assurance that days like today were just corrections. Such hubris from losers like this is a sign that Mr. Market is going to spank them some more in due time.

The bottom line is that correction or not, one day wonder or not, odds strongly suggest that the bull market is still in tact. History shows bull markets end when the general public is optimistic about the economy, investors/bankers are greedy and monetary conditions are tight. None of the above are anywhere close to being in existence. Anything less than that is just noise. Events that don't have a material direct impact on broad based earnings will not threaten a bull market aside from creating dips and corrections. Oil prices spiking 7% as significant as it appears to be, it likely not going to effect earnings in a material way. But it's certainty not a positive and with the market up 28% in under 6 months not to mention up 100% in just under 2 years, it provides a reasonable excuse for a pullback. Is this going to be the start of the multi-month consolidation phase I'm expecting? We'll find out soon.....my gut says that the "real" correction won't begin until today's gap is at least filled. Whatever....I'm not going to position myself for a downside trade unless I'm absolutely certain it's going to be more than just a 1-3 day move...and I'm not. I'm happy to stick with my core longs and cash position regardless. Most of my longs are in the energy services sector which actually benefits from this spike in the oil price. They closed flat overall today.

I want to talk a bit about my previous post. Did anything from it really hit home? Reminiscences of a Stock Operator was written over 70 years ago and yet the insights it provides about the markets and human behavior remain true to this day. In this book you will find no mention of things like Fibonacci retracements levels, boligner bands, moving averages, elliot waves and all the other arbitrary t/a garbage that so many people out there use. And yes....all that stuff is garbage in my view. I'm sure you've heard statistics that say something like 90% of traders fail. Well, guess what 90% of traders based their trades on? All of the t/a bullishit I just mentioned. I'm sure there are a handful of traders out there who are successful using a pure t/a approach but I'll tell you right now, such people are in a tiny minority and quite frankly, could simply be very lucky.

I don't think all t/a is useless. In my experience certain chart patterns have been reliable such as consolidations/bull flags in an uptrend. But there's nothing voodo/arbitrary about this pattern. It's simply the reflection of new buyers soaking up shares from profit takers who got in at lower levels. Every big winner I've had in the past 2 years was the result of buying stocks that were in a consolidation phase during an non-parabolic uptrend.

The important things I learned throught the years is exactly what Jesse Livermore in Reminscenses pointed out which is the following

1. When you're right, sit tight and add more to your position. When you're wrong get out early and don't ever average down. Most people do the opposite. They sell winners too soon and hold on to the losers forever while adding more to them. Just because you show a nice profit in your position doesn't mean you should sell. If you have good reason to believe that the price is going to go a lot higher still in the longer run (or lower if you are short) then you need to resist the temptation of getting out in the hopes of getting back in on a correction. You might time it right in the beginning and save yourself a few dollars but eventually you'll find yourself on the sidelines watching the stock soar without you and miss out on the big gains. I'm sure everyone who reads this had made this mistake at least once....including yours truly. This was the lesson Partridge had learned over the years.

2. Big money is made riding trends. This goes hand in hand with the first point. Big money is made riding big trends/themes. I'm sure you've heard about how George Soros made a fortune shorting the pound in the early 90's and how some hedge fund managers made killngs bettng against subprime mortgages 3 years ago. Do you think these guys day traded or used bollinger bands and elliot waves? Their trade was based on fundamentals, they had a thesis and they had conviction/courage to stay the course WHEN THEY WERE RIGHT ABOUT THEM. I wrote this in caps because it's a very important point. You need to have conviction with your position when you are right i.e. showing a profit, NOT when you are wrong. Having strong conviction when you are wrong will destroy you like all these loser bears have been destroyed. But when you have thesis and the market is agreeing with you i.e. you are showing a profit then you need to have the conviction to follow through on your thesis and hold your position untill you believe it has fully played out. Having conviction allows you to be a strong holder not getting shaken out by dips and corrections that the market throws at you.

I realize that it's difficult to be right and sit tight, riding out all the dips and corrections. I know it's also difficult not take profits after your position had a big run up. Let's face it......sometimes our convictions are just not strong enough and we can't resist the urge to trade. So what can you do about this? Designate a portion of your position as a trading position while keeping a core position. This is something I often do. I will designate up to 1/3 of my position as "trading". If you do this, you must have the discipline to not touch your core position until it's time to sell out for good.

There's lots of people out there I'm sure, who would say you need to trade without conviction....they believe the best approach is to have no opinion and just follow the market. Well, I don't agree and it's not that easy to just "follow the market". First of all, the market is not always right...in the sense of what it's discounting. This tends to happen especially during manias and panics. I'm also sure you've heard of the saying that goes along the lines of "the market has predicted 8 of the last 5 recessions" which basically means, it's not always right. So, if you go strictly with the "go with the market" approach you could find yourself long near a major top, or short near a major bottom. It makes you a weak holder unable to successfuuly ride the major trend because you will get easily shaken out by dips/corrections and even worse, get suckered into believing that a correction indicates a change in trend. A lot a loser permabear traders tried to take the "go with the market" approach and could not play the long side successfully because deep down they didn't believe in the bull market which made them weak longs easily shaken out by small dips.

I also believe that if you're going to play this game, play to win big but do it smartly. The financial markets offer you potential for massive financial success but you cannot attain that with diversified portfolio. It will guarantee you mediocracy at best. If that's all you're looking for then fine. But if you're good at predicting financial trends and picking stocks, you need to make significant bets on a handful of positions/sectors to maximize your potential. But NEVER under any circumstances go all in on 1 individual stock/sector/idea. Doing so puts you in a position to get wiped out if you are wrong and no matter how good you are you're bound to get it wrong sometimes.

Getting back to the conviction issue....here's the way I operate. If I have a belief about the market, a sector or a stock I first want to see some evidence that the market is agreeing with me. The only exception I may make to this rule is if I believe there is a mania or panic in it's final innings and I'm looking to bet the other way. In that case, waiting for the market to confirm would mean missing out on a substantial part of new trend because the initial reversal from a mania or panic tends to be fast and furious. But regardless of the circumstances, when I place a trade I only commit 35-50% of my intended position. This way, I can be a strong holder, giving my position plenty of time and wiggle room to prove itself. I will then add to this position only if I'm showing a profit and the position is acting like I expected it to. By trading in such a manner I believe you combine the benefits of trading with conviction and "going with the flow" by trading with the market trend.

The question that traders will struggle with is where do you draw the line between having conviction on a trade (i.e. giving it the opportunity to be profitable) and pulling the plug on it? Well, that depends on a lot of factors and there's really no way of telling where to optimally draw that line in the sand but one thing's for sure is that there needs to be such a line otherwise you'll end up as a bitter, miserable SOB always looking at the market with contempt....not to mention broke.

Partridge had it right

As traders still bang their heads against the wall for missing or shorting this great bull market, I think it's fitting that I talk about Partridge again. He's a character from my favorite stock market book Reminiscences of a Stock Operator. Here's the actual excerpt from the book telling his story. It's a long read but well worth it.
(by the way if you want to read the entire book online for free click here)


Most -let us call 'em customers -are alike. You find very few who can truthfully say that
Wall Street doesn't owe them money. In Fullerton's there were the usual crowd. All
grades! Well, there was one old chap who was not like the others. To begin with, he was
a much older man. Another thing was that he never volunteered advice and never
bragged of his winnings. He was a great hand for listening very attentively to the others.
He did not seem very keen to get tips that is, he never asked the talkers what they'd
heard or what they knew. But when somebody gave him one he  always thanked the
tipster very politely. Sometimes he thanked  the tipster again when the tip turned out
O.K. But if it went wrong he never whined, so that nobody could tell whether he
followed it or let it slide by. It was a legend of the office that the old jigger was rich and
could swing quite a line. But he wasn't donating much to the firm in the way of
commissions; at least not that anyone could see. His name was Partridge, but they
nicknamed him Turkey behind his back, because he was so thick-chested and had a habit
of strutting about the various rooms, with the point of his chin resting on his breast.
The customers, who were all eager to be shoved and forced into doing things so as to lay
the blame for failure on others, used to go to old Partridge and tell him what some friend
of a friend of an insider had advised them to do in a certain stock. They would tell him
what they had not done with the tip so he would tell them what they ought to do. But
whether the tip they had was to buy or to sell, the old chap's answer was always the
same.
The customer would finish the tale of his perplexity and then ask: "What do you think I ought to do?"
Old Turkey would cock his head to one side, contemplate his fellow customer with a
fatherly smile, and finally he would say very impressively, "You know, it's a bull
market!"
Time and again I heard him say, "Well, this is a bull market, you know!" as though he
were giving to you a priceless talisman wrapped up in a million-dollar accidentinsurance policy. And of course I did not get his meaning.
One day a fellow named Elmer Harwood rushed into the office, wrote out an order and
gave it to the clerk. Then he rushed over to where Mr. Partridge was listening politely to
John Fanning's story of the time he overheard Keene give an order to one of his brokers
and all that John made was a measly three points on a hundred shares and of course the
stock had to go up twenty-four points in three days right after John sold out. It was at
least the fourth time that John had told him that tale of woe, but old Turkey was smiling
as sympathetically as if it was the first time he heard it.
Well, Elmer made for the old man and, without a word of apology to John Fanning, told
Turkey, "Mr. Partridge, I have just sold my Climax Motors. My people say the market is
entitled to a reaction and that  I'll be able to buy it back  cheaper. So you'd better do
likewise. That is, if you've still got yours."
Elmer looked suspiciously at the man to whom he had given the original tip to buy. The
amateur, or gratuitous, tipster always thinks he owns the receiver of his tip body and
soul, even before he knows how the tip is going to turn out.
"Yes, Mr. Harwood, I still  have it. Of course!"  said Turkey gratefully. It was nice of
Elmer to think of the old chap. "Well, now is the time to take your profit and get in again
on the next dip," said Elmer, as if he had just made out the deposit slip for the old man.
Failing to perceive enthusiastic gratitude in the beneficiary's face Elmer went on: "I have
just sold every share I owned!"
From his voice and manner you would have conservatively estimated it at ten thousand
shares. But Mr. Partridge shook his head regretfully and whined, "No! No! I can't do
that!"
  
"What?" yelled Elmer.
"I simply can't!" said Mr. Partridge. He was in great trouble.
"Didn't I give you the tip to buy it?"
"You did, Mr. Harwood, and I am very grateful to you. Indeed, I am, sir. But "
"Hold on! Let me talk! And didn't that stock go op seven points in ten days? Didn't it?"
"It did, and I am much obliged to you, my dear boy. But I couldn't think of selling that
stock."
"You couldn't?" asked Elmer, beginning to look doubtful himself. It is a habit with most
tip givers to be tip takers.
"No, I couldn't."
"Why not?" And Elmer drew nearer.
"Why, this is a bull market!" The old fellow said it as though he had given a long and
detailed explanation.
"That's all right," said Elmer, looking angry because of his disappointment. "I know this
is a bull market as well as you do. But you'd better slip them that stock of yours and buy
it back on the reaction. You might as well reduce the cost to yourself."
"My dear boy," said old Partridge, in great distress "my dear boy, if I sold that stock now
I'd lose my position; and then where would I be?"
Elmer Harwood threw up his hands, shook his  head and walked over to me to get
sympathy: "Can you beat it?" he asked me in a stage whisper. "I ask you 1"
I didn't say anything. So he went on: "I give him a tip on Climax Motors. He buys five
hundred shares. He's got seven points' profit and I advise him to get out and buy 'em
back on the reaction that's overdue even now. And what does he say when I tell him? He
says that if he sells he'll lose his job. What do you know about that?"
"I beg your pardon, Mr. Harwood; I didn't say I'd lose my job," cut in old Turkey. "I said
I'd lose my position. And when you are as old as I am and you've been through as many
booms and panics as I have, you'll know that to lose your position is something nobody
can afford; not even John D. Rockefeller. I  hope the stock reacts and that you will be
able to repurchase your line at a substantial concession, sir. But I myself can only trade
in accordance with the experience of many years. I paid a high price for it and I don't
feel like throwing away a second tuition fee. But I am as much obliged to you as if I had
the money in the bank. It's a bull market, you know." And he strutted away, leaving
Elmer dazed.
What old Mr. Partridge said did not mean much to me until I began to think about my
own numerous failures to make as much money as I ought to when I was so right on the
general market. The more I studied the more I realized how wise that old chap was. He
had evidently suffered from the same defect in his young days and knew his own human
weaknesses. He would not lay himself open to a temptation that experience had taught
him was hard to resist and had always proved expensive to him, as it was to me.
I think it was a long step forward in my trading education when I realized at last that
when old Mr. Partridge kept on telling the other customers, "Well, you know this is a
bull market!" he really meant to tell them that the big money was not in the individual
fluctuations but in the main movements that is, not in reading the tape but in sizing up
the entire market and its trend.
And right here let me say one thing: After spending many years in Wall Street and after
making and losing millions of dollars I want to tell you this: It never was my thinking 
that made the big money for me. It always was my sitting. Got that? My sitting tight! It 
is no trick at all to be right on the market. You always find lots of early bulls in bull
markets and early bears in bear markets. I've known many men who were right at
exactly the right time, and began buying or selling stocks when prices were at the very
level which should show the greatest profit. And their experience invariably matched
mine that is, they made no real money out of it. Men who can both be right and sit tight 
are uncommon. I found it one of the hardest things to learn. But it is only after a stock 
operator has firmly grasped this that he can make big money. It is literally true that
millions come easier to a trader after he knows how to trade than  hundreds did in the
days of his ignorance.
The reason is that a man may see straight  and clearly and yet become impatient or  
doubtful when the market takes its time about  doing as he figured it must do. That is 
why so many men in Wall Street, who are not at all in the sucker class, not even in the 
third grade, nevertheless lose money. The market does  not beat them. They beat
themselves, because though they have brains they cannot sit tight. Old Turkey was dead 
right in doing and saying what he did. He had not only the courage of his convictions but 
the intelligent patience to sit tight.  
Disregarding the big swing and trying to jump in and out was fatal to me. Nobody can 
catch all the fluctuations. In a bull market your game is to buy and hold until you believe 
that the bull market is near its end. 

2004 redux?

Here's an interesting article posted by Dennis. It in it's mentions how the retail investor is returning to the market with Janurary showing the largest monthly increase into stock funds since early 2004 and the first positive monthly inflow since April 2010. Anyone with a bearish mindset would immediately point out this behavior as a bad sign for the market. After all, the last time monthly inflows were positive was just prior to the market correcting 15%. Admittedly, I would agree that the retail investor is terrible at market timing and this could be viewed as ST negative. However, I've always said the following when it comes to market sentiment: In bull markets bullish sentiment is to be expected and therefore can be tolerated for quite some time without having any bearish consequences (the same thinking goes with bearish sentiment in bear markets) We have seen this happen just recently with the sentiment surveys. They have been screaming "too bullish" since October and yet the market has pretty much ignored it (aside from small pullbacks) and continued climb a lot higher since then.

In the article it mentioned this

"For 23 consecutive weeks, surveys by the American Association of Individual Investors have shown a greater-than-average belief that stock prices will rise. The last time the surveys had such a long streak of bullish sentiment was in 2004"

I talked about this in early December. Here's what I said:

"Regarding sentiment. I looked back to see if there was ever a notable time when the market ignored the contrarian implications of excessive bullish sentiment for a long time. There was. It was in the summer of 2003. From the summer of 2003 until the end of the year, AAII sentiment averaged over 4:1 bulls vs bears, Investors Intelligence average 3:1 bulls vs bears and the VIX traded below 20 most of the time. Yet despite what appeared to be very excessive and chronic bullishness for months, never mind weeks, the market still trended higher with only minor dips closing out the year on the highs."

The high bullish sentiment I was talking about above also spilled over into early 2004, so to be more accurate I should have said it was in place until early 2004.

So, based upon the info provided in the article, current sentiment conditions are similar to that in early 2004 when you look at AAII sentiment and mutual fund investor behavior. Economically, there are also similiarities. In both periods, ST Interest rates were rock bottom even though the economy had clearly turned up from a recession well over a year ago with strong earnings growth for over a year as well. Jobs gains were picking up but were still volatile from month to month with strong months and weak months. However, towards the end of q1 and onward in 2004, the monthly job gains were consistent and large. Thus, the surge in bullish sentiment was justified back then because evidence was building that the economic upswing was sulf-sustaining. But ironically, March of 2004 marked an IT top as investors began to deal with the prospect of fed tightening which did end up occurring starting in June of 2004. That kept a lid on the market for many months as it basically went sideways with a downward tilt until October (If you want to see how the market traded in 2004 go back to a post I made in early January).

We could be at a similar cross-roads right here. Aside from serial top picking gone wrong, the relentless rally we've been seeing in the market could be the anticipation that jobs are going to be coming back in a big way proving strong evidence that the economic recovery self-sustaining. So, like in early 2004 the catalyst to mark a IT top could be the worry that the fed is behind the curve and that they will soon start "taking away the punch bowl" by raising rates and ending QE. I think there's a very good chance this worry is going to come to fruition. Leading indicators for growth such as ISM data and corporate profits have been yelling and screaming this for months. Employers have been slow to hire because the wounds of 2008 haven't fully healed. But it's just a matter of when not if they start hiring in a big way if you ask me.

If I'm right about what I just said, we could see a prolonged consolidation phase like in 2004 begin shortly (within the next month or 2) as investors start pricing in the normalization of rates and reversing QE. Now, I realize I'm looking ahead quite a bit here and I could be completely wrong....I'm just fleshing out a thesis here that think could  happen based upon evidence and experience. I also realize that when you have thesis you need to be careful not to be a victim of confirmation evidence bias. We'll just have to see what happens in the never ending soap opera known as the stock market.

I should also mention the consolidation phase in 2004 was fairly mild with respect to downside. The market had declined 10% from peak to bottom during a sideways phase that lasted about 6 months. During this phase, bears viewed the market as topping out....they ended up getting their asses handed to them in a big way as the bull market resumed course for another 3 years. And as far as retail investors returning to the market, those inflows in Januarary is just a drop in the bucket compared to all the money that was pulled out in 2008 and 2009. We have a long way to go before mutual fund inflows show any exuberance.

Bizzaro world in full force

On bigcharts.com today I noticed the following news headline

"Will and Kate to wed in dour economic times"

Right underneath that headline was this one

"Midcap stocks rally above 2007 high"

It's yet another example of how media sentiment is badly lagging the powerful bullish message of the stock market. Here we are with the market exploding to the upside for nearly 2 years and consensus sentiment out there from the media and main street is that the economy is still "dour". And it's not just this one article that proves this. I've proved it with several other examples in the recent past. And the bears want you to believe that everyone is bullish. Do you honestly think a bull market top is going to be made when the general public never turned even remotely positive about the economy with monetary conditions still extremely accommodative?Good luck with that....never has a bull market ended this way. Bears keep pointing out how sentiment surveys and insider selling are screaming bull market top. I'm not going to go over again why these bears are misusing these indicators. Suffice to say that at best they can indicate a ST/IT peak but even that has been stymied for over 2 months now because of group think. Then of course, there's the conspiracy theories about how the fed is buying stocks or the dismissal of the bull market as simply a result of the flood of liquidity in the system. But not a fucking single mention is made from these losers about how earnings are poised to make new all time highs....not one. Do you think that maybe, just maybe the bull market has been the result of these earnings and not POMO, QE2, conspiracies and other bullshit? Nah, couldn't be....it's gotta be the conspiracy...because this way these losers don't feel so bad about themselves for losing money or missing out since they were helpless against such a supposedly rigged market. What a bunch of fucking pathetic, bitter, miserable and in denial SOBs.

What an interesting time to be involved in the stock market. It's complete bizzaro world from when I first ever got involved over 12 years ago. Never did I think I'd see the day where people keep complaining about the market being so strong making new highs! Think about how fucking retarded and sad this is. Aren't most people who play the stock market supposed to like such environments? Funny how nobody was complaining in 1999 and early 2000 when the market was soaring then. That's because the herd was euphorically long and had no problems chasing. Now that the herd has largely missed out or shorted this monster of a bull market you here all this whining and complaining. Fucking losers. Future generations of investors are going to look back at this period and wonder how people could have been such stubborn, miserable SOBs just how we look back to 1999-2000 and wonder how people could have been such suckers in buying tech stocks at such insane valuations. I don't meant to sound arrogant....I'm just venting here.


Let's put things into perspective here in the medium term. If you annualize the 4.5% gain in the SPX year to date you will get a return of about 45-50%. Clearly that's not going to happen and so it means the market is "ahead of itself" even if we are going to have a good year. That means that sooner or later we're probably going to get a consolidation phase similar to what happened in the summer but I don't think the downside will be nearly as severe. Perhaps it will be due to concerns about Emerging market tightening, the ending of QE2 in June...who knows for sure what will be the trigger. This consolidation phase will likely shake out the Johnny come lately bulls who are weak handed.


When does this consolidation phase begin? Probably when all those correction callers become humble and just STFU. In addition, there's nothing stopping the market from going higher for a while still and then cooling off for several weeks/months later on. With the market closing at fresh 29 month highs and plenty of top picking still going on, it's quite likely that we haven't seen the IT peak just yet. Even if I'm wrong about this, I'm sticking with my core positions and cash cushion.

Loser bears

Yet another 2 year high today. Bears, who continue to be embarssed so badly are still digging in their heels. The higher the market goes, the angrier and bolder they have been and it's not just recently. It's been going on since the summer of 2009. Mr. Market loves no better than to humiliate those who are wrong and show no respect for him digging in their heels like this...guys like Hussman, Faber, Schiff, Roubini and my fav Pretcther to name a few.

And the funny thing is the media and financial blogs out there still love to quote the opinions of these wrong way bears which shows they are still held in high regard despite being hideously wrong for so long and that to me says that the public is nowhere close to fully embracing the bull market which is a bullish LT sign. Sure, these bears were right about the crash but they were dead wrong about the bull market. Not only that, but they didn't fully capitalize on the crash either having covered shorts far, far too early and some even lost money going long too early playing a "bounce" that never came.

All those correction calls we've been hearing about for over 2 months have been dead wrong. I realize the market is "extended" but I rarely have I seen meaningful corrections begin when so many people are bracing for it and I've been right in saying that it wouldn't happen just yet. Last week there was high put buying every day....not extreme but on the high side considering the market was strong. This to me indicated yet again for the thousandth time since September, top picking behavior from worrywarts and stubborn bears which only ends up adding fuel to the fire. I thought there would have been a little bit more downside follow through after the pullback 2 Friday's ago but that didn't happen...didn't matter though because I wasn't expecting much of a follow through anyways.

Like I said before, I'm not going to concern myself too much about the ST wiggles of the market. Now, if I get the sense that a meaningful correction is indeed immanent I may take action but it won't be a major bet and if in doubt I will remain status quo because I'm still LT bullish and I have a comfortable cash position to allow me to sleep at night correction or no correction. Despite my cash position my account has been on fire with sizable breakouts in tec.to, wzl.to and isc.v all of which are in the Canadian small cap energy services sector. So far so good for me in 2011 but I won't ever get complacent or develop of swell head....even though my profile pic suggests I have one.

Valuation

Based upon Q4 earnings reports rolling in, Zacks estimates that SPX earnings for 2010 will come in at about $83 per share. At the begining of 2010 the average forecast for SPX earnings was $77 and I heard several pundits warning about how they believed analysts were "too optimistic". Well, turns out they weren't optimistic enough which in bull markets tends to be the norm. Do you remember in 2008 how every quarter analysts always over estimated earnings even though they were slashing them day by day? They were never pessimistic enough!

Let's put this latest earnings figure into perspective. The highest annual EPS ever recorded for the SPX was about $88 in 2006. The market is now poised to smash this record in 2011 with EPS estimated to be $95 for the year. If that ends up being the case where do you think the market will trade at? If the market has record earnings don't you think it should trade at record highs? It's seems logical to make such a conclusion but you have to consider other factors. For instance, the last time the market was at record highs was it "justified" to be at such highs? If not, then using that previous high as a benchmark is not appropriate.

In 2000 the SPX made a peak at around 1550 as it did in 2007. Earnings in 2000 was about $56 which gives you a p/e of about 28.....clearly excessive. In 2007, when the SPX also peaked at about 1550 it had much higher earnings that time around which was $82.50. That gives you a p/e of about 19....not off the charts excessive but historically high. How about now? Based upon current forward earnings, the p/e of the market is 13.7. That's not excessive by any means. Even if the market was trading at the all time high of 1550 it would have a p/e of about 16 which is a little above above the historical average of 14. Then there's the interest rate factor. The lower the level of interest rates (I'm talking about long bond yields here, not the fed funds rate), the more "justified" a higher p/e multiple for stocks is and so therefore, the fair value p/e for stocks should be adjusted for interest rates. With interest rates as low as they are now, it makes the market look even cheaper...even if rates go up another 1% or so they would still be historically low and stocks would still be attractive on a relative basis. However, there is a major flaw with the interest rate adjusted valuation method - the so called "fed model". Lower trending interest rates could be a reflection of the market's expectation for a weak economy and if that turns out to be true, future EPS for stocks would likely contract significantly and therefore stocks wouldn't be attractivily valued as they appeared to be. This is what happened in 2007-2008. Stocks were still considered undervalued according to the fed model when they peaked. This made a lot of bulls out there complacent.

The fed model is currently suggesting stocks are still considerably undervalued but this time around I don't think it's giving a false signal because for the past 2 years interest rates have been low and earnings have been rising sharply. Thus, low interest rates this time around have been a reflection of high risk aversion and low inflation due to excess capacity and not an omen of declining economic activity.

So, all in all, it appears as though the market is undervalued to fairly valued assuming that earnings will be what they are expected to be and don't be suprised to see earnings come in better than expectations yet again. I realize that valuation is subjective and pundits bicker about it with each other to no end. Market valuation also tends to make people victims of dogma. They tend to think that their method is "right" and that the market is going to adhere to their view and magically stop rising or falling when such and such valuation parameters are hit. And then of course, they get run over when it doesn't happen. That's why when it comes to valuation it's not the primary driver of my decisions because nobody can know for sure what "fair value" really is and even if you did, the market tends to overshoot and undershoot fair value and can do so for prolonged periods of time.

I wanted to talk about valuation because although is argueable as to what fair value of the market actually is, the evidence says that the market has just about as much earnings backing it up now as it did when the market was at an all time high of 1550 about 4 years ago, plus interest rates are notably lower now making todays earnings more "valuable". Therefore, at 1300 it's not a stretch to envision the market going up another 20% from here within 1-2 years. And if earnings end up making new all time highs in 2011, it's not a stretch to envision the market making new all time highs within 1-2 years especially with LT sentiment conditions also supporting the notion that the market has more room to advance before people are truley "too bullish".