Still A Sideways Stock Market? Or, A Bubble?

Includes: DIA, QQQ, SPY
by: John M. Mason

On March 28, 2013, the S&P 500 closed at a new record high of 1,568.93, which was above the previous high achieved on October 9, 2007 of 1,565.15.

In an attempt to put this record into context, I will refer to something I wrote last November: the sideways stock market. The basic thrust of the post was that the United States stock market, as represented by the S&P 500 stock index, had roughly been trading within a range since 2000 with a peak somewhere between 1,500 and 1,600.

The following chart captures the story very well.

Given this picture, one must ask a question about whether or not the new high reached by the S&P 500 is a "breakout" from this range or will the index fall back once again into the pattern of the past 13 years.

There are two arguments that quickly come to mind that support a return to the previous range. The first has to do with "regular" cycles. This argument contends that for the past eighty years, the stock market has traveled in roughly 17-year cycles. They are as follows: In the 1933 to 1950 period the stock market moved roughly sideways; in 1950 through 1966 there was stock market growth; in the 1966-1983 period the market moved sideways again; in the 1983 to 2000 period the stock market grew again; and since 2000 the market has mover sideways again.

Given this scenario, the stock market still has about four more years to go in its sideways movement before it resumes an upward trend.

However, there is no economics behind this. Therefore is it just a coincidence of history?

The second argument against a "breakout" is that the United States economy is still experiencing only tepid economic growth… and that there is very little evidence to think the situation will improve much in the near future.

Analysts and government officials continue to look for "green shoots," an apt term for the spring of the year although they don't call them that anymore, to justify their optimism that the economy is getting stronger. But, they have been looking for "green shoots" for four years now.

Still, without the economic growth, it is hard to project much improvement in the profit picture and if there is no improvement in the profit picture, how can higher stock prices be supported?

Higher stock prices can be justified if one expects that corporate earnings will be increasing in the future so as to underwrite the higher stock prices. However, the higher corporate earnings don't seem to be forthcoming. In fact, if one looks at the Yale economist Robert Shiller's data (, one sees a decline in both nominal earnings as well as real earnings declining.

This is important because of the importance Shiller gives to his Cyclically Adjusted Price Earnings (CAPE) ratio. This ratio can be used to determine whether or not the stock market is over-valued or under-valued. Currently, for March 2013 Shiller's estimate of CAPE is 22.57. The average for CAPE, historically, is somewhere around 15. It is argued that if CAPE is above the historical average, there will be a reversion to the mean at some point… although the timing of this cannot be forecast.

An above average CAPE is not bad, if one expects that earnings will be improving in the near future. That is, stock prices may be high in anticipation of higher corporate earnings and, consequently, the CAPE will fall as these earnings catch up with the higher stock prices. This is the "good" scenario.

The "not-so-good" scenario is when stock prices increase, yet, earnings do not rise to support the higher stock prices. The question is… is this situation we are now in?

And, if this is the situation we are in, one where stock prices have risen without a future rise in corporate earnings, what has caused the S&P 500 stock index to break out to a new high?

One possible answer to this is that Ben, the Bubble-Blower, Bernanke has helped to create another bubble. Of course, Mr. Bernanke doesn't worry about bubbles. Still, what Mr. Bernanke has done over the past four years is to create a wonderful environment for the wealthy to prosper. You throw enough money into the economy for a long enough period of time, then those that know or those that have the resources to know, learn to take advantage of it. And, this has basically been the policy of the Federal Reserve since 2008. Mr. Bernanke does not want to go down in the history books as the Fed Chairman who did not throw enough money into the economy to keep a more serious depression from happening.

So, we have a new high for the S&P 500 stock index. My view is that there is very little in the way of economic news to justify this new high. This does not mean that the stock market will not go higher. The only warning I can give is that if the stock market does go higher be prepared to be agile. I believe that stocks are generally over-priced now. Higher prices will just add to this condition. I don't believe that the economics can support these levels and sooner or later there will be a correction.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.