Bubble Times

It will end badly.  But timing the top gets harder when the Fed keeps its cautious rate hiking campaign.  The bond market has called the Fed's bluff.  They don't believe in 4 more rate hikes till end of 2018.  They are pricing in 1.5.  Janet Yellen blinked when the 10 year went from 2.10% to 2.39% and went back to being dovish.  That was the green light for investors to party on and make the bubble bigger.

But that is short term thinking.  Ironically, because of 2008, investors are now thinking short term and unwilling to tolerate big risks.  But that makes them get caught up in buying when things are optimistic, and dumping quickly when things start going down beyond a certain pain threshold.  And with the VIX so low, that pain threshold is pretty low, because investors have been lulled to sleep by such low volatility.  A 10% move down would seem like a shock to the system, when it's a fairly normal stock market volatility.

The end point will be the same.  It is just a matter of how much higher it can go before it gets back to more normal valuations.  And with normal valuations, we are talking a P/E of around 15 times GAAP earnings, not the pro forma nonsense that is used by the Street to tout stocks.  That would put the S&P around 1600 based on 2017 earnings estimates.  A 35% correction from these levels are needed to get to average valuations, which is where the market was in 2013.

After 8 years of a steady uptrend, with only a few corrections, it is hard for most traders to picture a scenario where the market goes down 35%.  All it would take would be for the economy to get bad enough that corporations wouldn't have the cash flow or the borrowing capacity to do stock buybacks.  You can guarantee that there will be equity fund outflows.  So without the buying power from corporations or retail, you will have to get to levels where value investors step in aggressively to counter retail outflows.  That level is probably around 1500-1600.

We have the ECB tomorrow and the Fed next Wednesday.  Those will likely be market positive, so I will probably wait till after Draghi does his usual dovish dance before going short.  We are at levels where the risk/reward is quite positive on the short side so am definitely eager to get started.