October 23, 2013 at 12:23 PM EDT
Dow Jones Industrial Average, S&P 500: Ready For A Stock-Market Crash?
INDEXDJX:.DJI, INDEXSP:.INX, NYSEARCA:SPY, NYSEARCA:DIA, DJI:DJI, CBOE:SPX, NQ:COMP, NY:XAX Related posts: Dow Jones Industrial Average: What Can We Learn From The 1987 Stock Market Crash? Dow Jones Industrial Average: Dow 16,000, or A Major Stock Market Crash? Dow Jones Industrial Average: Ready For Liquidation? Dow Jones Industrial Average: This Will Crush Stock Market Gains Dow Jones Industrial Average: What Is The Stock Market Telling Us Now?

market correction bearBill Hall: It’s common knowledge on Wall Street that the Federal Reserve’s monetary policy has eliminated all investing risks by propping up stocks since the low in March 2009.

This is my view: “I understand this point of view, but I strongly disagree with its underlying premise.”

Frankly, I wonder whether any amount of arm-waving will cause the average investor to examine his risk exposures, much less consider the prospect of a 40 percent-plus decline in the S&P 500 (INDEXSP:.INX) that would only serve to bring stocks back to historical valuation levels. The benchmark index yesterday rose to a record, bringing the gain so far this year to 23 percent.

But I get it. This time is different. The all-powerful Fed will not allow stocks to go lower. That’s why nobody cares.

That’s because, as financial writer Brandon Smith, says:

“Human beings desperately want to belong, but they also desperately want to understand the environment around them. Often the desire to belong and the desire to know the truth conflict. The idea of the majority view, or the ‘mainstream,’ gives people the sense that they are a part of a group, and at the same time, gives them the illusion of being informed.”

Stocks are currently overvalued because investor sentiment is overwhelmingly positive and the Federal Reserve’s monetary policies are so accommodating.
Stocks are currently overvalued because investor sentiment is overwhelmingly positive and the Federal Reserve’s monetary policies are so accommodating.

As an example, a couple of days ago I heard a well-known institutional Wall Street investor say stocks are “underowned” —  as if every share of stock presently in existence is not actually owned by someone. To assert that stocks can be “underowned” reflects either a misunderstanding of how markets work, or signals an intention to pass off overvalued institutional equity holdings to everyday investors.

All of this explains why the bears are gone, extinct, vanished. Among the ones remaining, many are people whom I would consider to be either perma-bears or nut cases. And, yet, the historical evidence for a major market drop has rarely been stronger.

Virtually every reliable measure of stock-market valuation is now within the highest 1 percent of historical observations prior to the late-1990s bubble. “Reliable,” in this context, refers to valuation measures that are well-correlated with actual subsequent market returns. Those measures include price-to-revenue, price-to-book, various cyclically adjusted price-to-earnings multiples, and market values-to-GDP, among others.

As evidence, consider this: At the market’s recent high, the Shiller price-to-earnings ratio (the S&P 500 divided by the 10-year average of inflation-adjusted earnings) of 24.6 matched that of September 1929 (a month before the crash that would lead to the 10-year Great Depression), exceeded the peak of 23 reached in March 1937 (the S&P 500 lost half of its value over the following year), matched the extreme of May 1965 (which ushered in a 17-year secular bear market) and significantly exceeded the level of 19.8 seen at the August 1987 peak (right before the global crash).

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Related posts:

  1. Dow Jones Industrial Average: What Can We Learn From The 1987 Stock Market Crash?
  2. Dow Jones Industrial Average: Dow 16,000, or A Major Stock Market Crash?
  3. Dow Jones Industrial Average: Ready For Liquidation?
  4. Dow Jones Industrial Average: This Will Crush Stock Market Gains
  5. Dow Jones Industrial Average: What Is The Stock Market Telling Us Now?

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