The latest up-move has occurred on hopeful signs for the economy. But hopes are running well ahead of reality. Last week’s great reading on GDP, for instance, had a headline number everyone could like, but a breakdown of the numbers suggest we’ll see sharp downward revisions with the subsequent releases. We’re also not encouraged by news out of the Federal Reserve yesterday that while banks have eased their lending standards, they’re still not growing their loan portfolios. If the economy is to reach sustainable growth, we’ll need greater bank lending.

 

The bank lending stat was overshadowed by a better-than-expected ISM Purchasing Manager’s Index reading. And while the economy can use all the help it can get, we’ll remind you that this has been a balance sheet recession, not a garden variety manufacturing one. With the jobless rate in double digits, housing turning down again and banks not lending any recovery is likely to be slow to unfold. If earnings don’t come on strong, investors are likely to mark down share prices.

 

One of the best technical indicators we use to gauge long-term overbought/oversold conditions in the market, the Coppock Guide (named for Edwin Sedgewick Coppock, who developed the indicator in the early 1960s), is telling us that the market has rarely been as overbought as it is today. For the market we’re referring to the unweighted average of all stocks traded on the New York Stock Exchange (NYSE). By treating each stock equally—rather than weighting them by capitalization as the S&P does, or by price as Dow is calculated—you get a better picture of the health of the market. How overbought is the market? The last time this indicator was as overbought as it is today (even after the selling of the last few weeks) was in May, 1983.

 

Any student of history will tell you that extremely overbought conditions aren’t necessarily bad and by in and of themselves aren’t sufficient cause for a correction. After all, strength can beget strength. But it does bear watching. In May 1983, for instance, stocks gained another 4 to 6 percent before topping out, and the correction that followed was relatively mild.

 

In May 1983, the economy was six months out of recession and growth was picking up speed. Today, plenty of economists will tell you we’re six months past the bottom in economic activity. And with the recent 5.7 percent print on forth-quarter GDP, it would seem the economy is accelerating (although as we mentioned above, to be honest we have our doubts on the economy’s staying power). And here is where the similarities end.

 

In ’83 stock market valuations were much lower, with the trailing 12-month P/E on the S&P 500 around 13 and the dividend yield at 4.3 percent. Today, in contrast, the market’s P/Es is north of 85 and a still astronomical 36 on the S&P Industrials (which exclude the ailing financial sector), while the dividend yield is a mere 2 percent. Back in ’83, “real” inflation-adjusted Treasury bond yields were 6.5 percent with inflation at 4 percent and falling. Today, real yields are 1.7 percent; inflation is 2.7 percent and rising. And in a measure of potential stock market buying power, mutual funds were holding an average of 9.9 percent of their assets in cash in 1983. Today, they’re hold just 3.6 percent, leaving them scant room to plow into stocks.

 

Again, today’s overbought conditions aren’t a surefire recipe for disaster. But they do underscore the risk of investing in equities at these levels, which is why we’re holding a mix of long and short positions these days.