Saint Petersburg, Russia. Source: Flickr

Dear Diary,

The Dow ended the session down 173 points yesterday, after falling more than 300 points during the day.

Press reports told us that investors were worried about weak US consumer sales and falling producer prices. Combined with falling crude oil prices, these make it look as though a European-style slump is coming to the whole world.

But what did you expect?

It is autumn. The days dwindle down… life closes in on you.

It comes as a shock. Like when you turn 60 and you suddenly realize that you are… alas… mortal.

You will not make an infinite amount of money in your lifetime; in fact, you’ve already made most of what you’re likely to make. You will not drink an infinite number of martinis… or have an infinite number of friends… or hear an infinite number of concerts.

Au contraire, the numbers in your life are limited… and probably already undergoing some shrinkage. Your height. Your savings. The years left to you… the number of times you’ll get sick or fall down drunk.

They’re all getting smaller. Then you have to think more carefully about what you’re going to do with the numbers you’ve got left.

CAPE Crusader

Bull markets are not unlimited either. They have life cycles. Their days are numbered even before they begin.

And if this is not the beginning of the end for this one, it must be the end of the beginning.

The bear waits… bides his time… and wonders how many desperate souls he will take down with him. Investors check their portfolios and wonder what to do with the money they’ve got left.

A single day does not a bear market make. But the closer you look at the US stock market, the worse it looks.

First, as we have been warning in these pages, it is overpriced. Ned Davis Research puts the Shiller P/E or CAPE (cyclically adjusted price-to-earnings ratio) of the US market at 23 – well over our limit of 20. Mebane Faber calculates it differently, and comes up with 25. Robert Shiller, who popularized the metric, puts it at just over 24.

By way of comparison, that makes US stocks about twice as expensive as shares in Britain. The CAPE for the British stock market is about 12.

And compared to Russia, US stocks are four to five times more expensive, per dollar of cyclically adjusted earnings. The Russian stock market trades on a CAPE of just 5.

Sell America… Buy Russia

If you knew nothing else – which is about what we do know – you could conclude that US stock prices are high and Russian stock prices are low. And if we followed the simplest, oldest and surest rule in the investment world, we would be out of the US and into Russia.

Buy low. Sell high. What could be clearer?

And what’s this? The mighty US stock market is suddenly looking weak and vulnerable. From MarketWatch:

In nontechnical terms, the October 8 manic rally was a head fake. It might have cheered amateur investors, but in reality, this has become one of the most dangerous markets since 2008.

Facts are hard to dispute but easy to spin. Already, the Russell 2000 is in a 10% correction. Judging by history, the Dow Jones Industrial Average shouldn’t be far behind. A major correction or crash would be definitive proof this market is wearing no clothes.

Failed rallies are extremely significant. Previously, whenever there were major or minor selloffs, buy-on-the-dippers would come in and change the market’s direction. On a chart, you’d see a distinctive “V” pattern as buyers overwhelmed sellers. This pattern has continued for months – until recently.

On the market’s worst days, the Fed would conveniently appear with a new QE program or a promise to keep interest rates low for a considerable time (that’s getting old). Soon, though, these bandages will not work. Failed rallies mean the party is almost over and a bear market is getting closer (and may even have arrived). 

Yes, dear reader, the bear market may have arrived. Or not. But it will come.

Regards,