Investors are much too bullish on stocks at this moment and we can see that in the Dow-Gold ratio, which is hitting a ratio of 9 to 1 as we speak.
I believe though, we shouldn't be so complacent about stocks. After all, the P/E ratio of the Dow Industrials stands at 15.3 right now, while in the 70's, the P/E ratio was on average at 10, which is much lower than 15.3. The question is: "Do we expect higher or lower earnings in the future?". I believe the earnings are going to get worse in the future. One way to measure this is to look at the Citigroup Economic Surprise Index (CESI). This index is defined as weighted historical standard deviations of data “surprises”. In human language it means that if the index turns negative, the chance of an "unexpected" downward revision goes up. You will hear more bad news out of the media. And what do you know, the CESI did turn negative in the previous month. So you can expect more bad news coming. Historically, when the CESI goes down, the stock market goes down a few months later as you can see on chart 1.
|Chart 1: Citigroup Surprise Index Vs. S&P|