Bullish Or Bearish The Markets? What Do The Charts Say?

 | Jun 17, 2015 12:00AM ET

During my morning reading, I ran across an interesting article from Alhambra Partner s yesterday:

"The bottom line is that GDP growth today doesn't necessarily mean stock price growth today – GDP growth and stock returns are not highly correlated. In fact, some analysis suggests that they are negatively correlated and perhaps fairly strongly so (-0.40)."

However, it isn't just Jeff Reeves pushing the bullish commentary, but virtually the entirety of the media press. The siren's song of "stay long my friends" has risen as of late as the market has struggled to gain ground this year. The reasoning for the continuance of the "bull rally" is footed by the common threads of: 1) interest rates are low, 2) corporate profitability is high, 3) economic recovery is stronger than it looks and; 4) global Central Bank interventions continue to put a floor under stocks.

The problem is that each of those points have been artificially influenced by outside factors. Interest rates are low because of the Federal Reserve's actions, corporate profitability is high due to accounting rule changes following the financial crisis, and the Fed's liquidity program artificially inflates stock prices. As far as the economy goes, I think it looks like it looks.

While the promise of a continued bull market is very enticing, it is important to remember, as investors, we have only one job: "Buy Low/Sell High." It is a simple rule that is more often than not forgotten as "greed" replaces "logic." However, it is also that simple emotion of greed that tends to lead to devastating losses. Therefore, if your portfolio, and ultimately your retirement, is dependent upon the thesis of a continued bull market, you should at least consider the following charts.

h2 Valuation/h2

I have often visited the point of valuations and the importance of them. However, valuations are often dismissed in the short-term because there is not an immediate impact on returns. Valuations, by their very nature, are HORRIBLE predictors of 12-month returns should not be used in any strategy that has such a focus. However, in the longer term, valuations are strong predictors of expected returns.

The chart below shows Dr. Robert Shiller's cyclically adjusted P/E ratio combined with Tobin's Q-ratio. The problem is that current valuations only appear cheap when compared to the peak in 2000. Outside of that exception, the financial markets are now more expensive than at any other single point in history.