Monday February 25, 2013 | Volume 90, Issue 5

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Bernanke’s Bubble: Setting Up the next Bear Market

by Steve Miller
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Amidst the backdrop of recessions in Europe and Japan and anemic economic growth in the U.S. the stock market has shown great strength in 2013. In fact, since its corrective low last November, the DJIA has vaulted some 1500 points or 18%. Add that on top of the recovery from the "financial crisis"

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and we have a 117% gain off the panic low in March 2009. The majority of analysts are quite exuberant; many seeing much higher levels for stocks for the rest of 2013. History says that might not be true.

The two things I want to examine in this article are the stock market's historical long-term patterns and more recent market influences that suggest stocks could be in trouble sooner than most think.

The onset of WWII came as the world was already battling to come out of the Great Depression. A historical bear market low came in 1942, which was followed by a bull market that lasted for 48-months. The bear market that followed lasted for 21 months, with the DJIA losing 25% of its value. That "cycle" measured from the low point of one bear market to low the low point of the next, lasted 69-months. Since that low, in 1949, the stock market has had 14, similar, and very recognizable cyclical patterns.

Table 1 shows the years of each bull-bear cycle, the length of the bull and bear phase, and depth of the following bear market. Also, you can see the length of each cycle; from one bear low to the next. Bull markets ranged from 16-months to 61-months. Bear markets ranged from just 3-months to as long as 38 months. The average cyclical length was around 54-months. What is very obvious is that long bull markets tended to be followed by short and sharp bear markets (1957-62 and 1982-87) and short bulls were followed by long bears (1974-78 and 1998-2002). So this historical record suggests; the current bull market, now 47 months old, is getting quite long. Therefore, it is likely that 2013 will see a bull market top, followed by a relatively short, likely sharp, bear market.

Table_1.jpg

So let's look at the recent history. Following a shallow bear-market low in 1998, the stock market roared ahead, driven by the explosion of the internet and the technology sector. Valuations in the tech stock got so high; they lifted the NASDAQ to 5000. The FED, fearing the overheating market, raised interest rates, as they do, to slow things down. The "tech bubble" popped, setting off a NASDAQ crash, with losses near 88%, and an economic contraction. Then, Fed Chairman Alan Greenspan responded, driving the fed funds down to 1%, in 2002.

Greenspan's actions, keeping interest rates very low for a very long time, lifted the stock market to all-time highs in 2006-07. It also pumped up the real estate market, already overly inflated by extraordinarily loose lending standards and irrational government policies. This was bubble II, "Greenspan's bubble." See, "Greenspan's Bubbles", by William Fleckenstein

Once again, the Fed's interference set up a huge problem. As interest rates rose, the massive real estate/mortgage bubble popped, and the stock market again crashed. Then Bernanke's Fed stepped in, again driving down interest rates. Since 2009, we have seen bailouts, ZIRP (Zero interest rate policy) and four rounds of QE (quantitative easing). While the economy did stabilize, economic growth and job creation has been very slow.

The actions of Bernanke's Fed have created $3 trillion, which the Treasury has taken on their balance sheet. During this period of poor economic growth, there has been one asset class with exploding growth; ETFs. Since the onset of these Feds actions, beginning in '08, the number of ETFs has rocketed from around 1700 to nearly 4000. Assets in ETFs, in the U.S. have exploded to over $1.6 trillion. With the economy stabile, gold and commodity prices flat; investors are looking for diversification and return. So money is pouring out if money-market funds into equity ETFs, which, in turn, are increasing their equity holdings and driving the stock market upward. This is "Bernanke's ETF Bubble."

So now, with the stock market nearing all-time highs, we have the third bubble in just 14 years.

As illustrated in the first part of this article, this bull market is historically long, with a likelihood of a relatively short bear market appearing in the near future. With the huge number of funds having moved into ETFs, once the Fed acts to withdraw stimulus and the market peaks, investors will all be trying to exit out of the same doorway. This could make for a very sharp market decline.

As the table above shows, the average bear market drops over 30%. And in all of this history, a bear market has never failed to appear following a bull. The chart below graphically shows what the past three bull-bear cycles have looked like, with a projection of the coming bear market.

BOTTOM LINE

So, while investors are pouring money into ETFs and driving stock markets upward, this could be a very good time to avoid the rush and begin your exit.

Chart 1, DJIA Monthly Bull-Bear Cycles

MontllyDJIABuLLBear2013-02-19-TOS_CHARTS

= = =

Read more trading ideas in our daily Markets section.

edjaworska1: Bernanke’s Bubble: Setting Up the next Bear Market http://t.co/QFrPl9QehJ via @TraderPlanet
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Visitor - jpesc: Steve I'd like to thank you not only for this article but also for the daily work you do on Tasty-trade, you've been a lot of help in my understanding of the markets. Keep up the great work.
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SteveMiller: Thanks so much! I hope lots of people read this and tune into the show!
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Visitor - Invis: Thanks Slim for this great article and all the work you do on your show. This article was very informative and a good read. I appreciate the work you put into this. Thank again
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SteveMiller: Thank you very much! Knowing my work is valued keeps me going. Thanks for watching Ask SLM.
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Visitor - supercellinterceptors: INDU is in a Megaphone Top Chart Pattern
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SteveMiller: Ah yes, and so is the NASDAQ. Also, the S&P 500 weekly is at the top of a very large bearish rising wedge. Lots of technical stuff out there top out this rally in suspicion. The caution is; sometimes, to set the hook, they have to run them a littler further than expected.
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circesdad: Steve, thoughtful and thought provoking article. Thank you for your fine work. The ever burgeoning ETF elephant is a favorite suspect of mine for the market doing the unexpected. During the last great volatility drought I wonder what the population and ownership level of the ETF's was then and how does it compare to now? 4,000 is a large group and with so much crossover in there investment themes I wonder what sector specific effects they can produce during sudden market fluctuations. No doubt we are about to see during the next topping experience. Warm regards. Mel
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SteveMiller: Thanks Mel! Yes, tons of crossover. All in all, market declines could look like 1987, when "portfolio insurance" caused a domino affect to the downside. Are ETFs like portfolio insurance? They're putting investments there to save costs and diversify; feeling safer? I do see the exit as a small door. The period of flat volatility might be an anomaly.
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Visitor - Derrrick: Bob the difference is that in 90s we were in a secular bull and now were in a secular bear.
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Visitor - Drew: Bob, just be aware that the potential is there and know what to do just in case, eh? SLM and tastytrade are always fading the "common" crowd and damn good at it!!
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Visitor - Bob: Disagree, this is not the time to be staging for an exit. The age alone doesn't kill of a bull market and folks that sell because prices have moved up usually end up on the wrong side of the trade, and jump back in right at the wrong time. What creates the "top" is excess. People borrow too much, companies spend too much, oil prices shoot up, investors get euphoric, stock valuation too high.

The average PE is 16, today's average PE is 15. The PE at the end of the 1990
s great bull market was 29.

Getting ready to execute an exit strategy today would be a mistake IMO. Especially when based on the narrow arguments presented in this article.
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MariaRinehart: Yes, it would seem as both you and Derrick pointed out that we are in a secular bear versus a secular bull as we were in the 80's and throughout the 90's. In 1982, the beginning of the secular bull market, the bear market in that cycle lasted a mere three months. The last secular bull began with low p/e environment and high inflation. Today, we have the opposite effect with low inflation and low p/e. I wonder if you are referring to Ed Easterling's work on secular cycles and the y-curve relationship of inflation and market p/e?
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SteveMiller: Bob, the subject of valuation would make a great article. General consensus is that the market is not expensive, historically, with a P/E of 15. However, there is not really a good comparative period, historically, outside of 2007-9. You know what happened then There is a reason fed funds are at zero and 10-year rates have been as low as 1.5%. Growth prospects have been terrible; economically, and though, corp earnings are doing OK, its based on cost cutting that diminishes future growth capacity. And they're sitting on cash and not growing their business because government intrusion gives little sense of true "organic" growth in the future. So without that, a P/E expansion to what used to be consider excessive is unlikely. Thanks for your comment.
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Visitor - jgooi: Corporations share buy-back schemes are creating an 'illusion' that 'artificially' boosting their EPS. Diminished revenues and reduced estimates are 'steroids' to prolong the bull's run. P/E ratio alone is not a good enough guide as a forward market indicator.
In fact, if you superimpose P/E ratio and historical market price, it gives you a 'nice' random walk that leads you to nowhere
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Visitor - trading@22: The market players use the interval .618 mutipied by number of days of a rally or selloff to determine how long they will hold the next wave of stock. The number of days between the low of sept 2002 to the lows of march 2009 is 2,339 days or 1,612 trading days. if you mutiply that by the fibonacci numeral .618 you get 996 days. then add 996 to the lows of march 2009 when the S&P was at 666 (we are now at 1500) plus. you get march 19th 2013 which was also the high of the market. here is a visual representation of that. http://screencast.com/t/91t3GwMMOm6
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SteveMiller: So a big top near March 13?
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SteveMiller: So you're saying that Mid-March is the timing for a market peak?
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Visitor - Jeff : I remember you talking about this early last fall on tastytrade with some great historical chartwork. I've pared down my longterm holdings a good deal, for this eventual move and to free principal for some sound trading strategies I've picked up from a friend of mine and from tastytrade. Can't wait to take advantage of the big correction.
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SteveMiller: Yes, Jeff. I expected a bull-market top to form into the first quarter of this year. Shorter-term patterns have been very positive, however. So there has not been a sign of it yet. Stay tuned
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Visitor - Alf Aucmonic: Excellent analysis Steve, from what I know of the market, we don't know a top is in until it is tested and the same with a bottom. I truly believe with all of this reckless printing of greenbacks and the horrible trillions of dollars of US debt, when we head down to test 6600, we will knife right passed it to make another low. Your cycle analysis will prove this true, it is just a matter of when!! Peace!
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Visitor - Great Article!: Great article!
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Visitor - Shirley: Hello SLM, I am one of your tastytrade fans. Thank you for this concise, informative article on the Bernanke bubble. I especially appreciate the explanation as to why the correction will be so short-lived, as well as why the bull is so long. Aloha
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SteveMiller: Aloha Shirley. Thanks so much!
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Visitor - Lobo77: We Tasty Traders love you, SLM!
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SteveMiller: Hey Lobo!
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Visitor - Wally: The author's hair, whilst ludicrous, is spectacular.
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SteveMiller: Does this mean you like it? Ha, I'm kinda stuck with it now.
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MariaRinehart: Great study. Thank you for the data to study as well.
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SteveMiller: Thanks Maria, I did want to give a quantitative background for the article. As you mentioned above, I also believe the markets are in a deflation-driven secular bear market. A mere whiff of a withdrawal of the stimulus brings sellers. I think the secular bull/bear background will be answered only by the depth of the next bear market.
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About the Author

Watch Steve Miller, Host of Ask SLM, daily 12:00 to 1:00ct, at tastytrade.com

Steve Miller, known as “Slim”, from his SLM badge on the CBOE,  has spent the last 39 years trading stocks, options, futures on and off the Chicago trading floors.  Throughout his career, Steve has studied technical analysis of the financial markets, emphasizing cycle studies in his short-term swing trading style. Active as a certified facilitator in personal growth work the past eighteen years, SLM has coached many men and groups, integrating personal healing and leadership, and continues to actively facilitate people in their quest for a joyful and fulfilling life.  Steve also wrote, “Ask Slim” for six years, a monthly Q&A on trading and the financial markets for SFO Magazine

Combining his many years of financial market experience with his training in personal growth work, Steve brings a rare combination of broad trading knowledge and understanding of the psychological barriers to trading success. To see more of Slim’s bio, his coaching programs and other offerings, please go to www.askslim.com

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