The topic of the day from a short-term perspective is the state of the geopolitical issues in Ukraine/Russia and to a lesser extent Iraq and Gaza/Israel. The way this game is played is simple, really. When headlines speak of troop movements, stocks go down. Then when the news wire reports that tensions have eased (as is the case this morning), stocks go up. And most importantly, it is vital to remember that once the geopolitical issue that captured the market's attention for a spell is over, oftentimes so too is the corrective phase brought on by the bad news.

Will the news that Ukraine and Russia have come to some sort of agreement on the convoy of humanitarian aid mean that traders and their fancy trading machines will soon turn their attention to something else? Will the easing of tensions mean another round of new highs for the major stock indices? Time will tell, of course. But things are looking up around the globe on Monday morning.

The Bigger Picture Concern - Valuations

However, from a longer-term perspective, the current level of stock market valuations is quickly becoming a topic of interest amongst analysts. Therefore, we will continue the thorough review of valuation indicators - something that could take a week or two to complete.

In fact, Nobel-Prize winner Robert Shiller wrote a piece in this weekend's New York Times suggesting that stocks "look very expensive right now" and that investors should be worried.

"The CAPE ratio, a stock-price measure I helped develop - is hovering at a worrisome level...nothing I've come up with is a slam-dunk explanation for the continuing high level of valuations. I suspect that the real answers lie largely in the realm of sociology and social psychology - in phenomena like irrational exuberance, which, eventually, has always faded before. If the mood changes again, stock market investments may disappoint us."

The CAPE Ratio

In case you are not aware, Shiller's CAPE ratio - the cyclically adjusted price-to-earnings ratio - is a long-term valuation metric designed to adjust for inflation.

According to Wikipedia, "The cyclically adjusted price-to-earnings ratio, commonly known as CAPE, Shiller P/E, or P/E 10 ratio, is a valuation measure usually applied to broad equity markets. It is defined as price divided by the average of ten years of earnings (Moving average), adjusted for inflation."

In addition to Shiller's own warning that his CAPE Ratio is worrisome right, a handful of analysts, including Ned Davis, have also noted that the CAPE is currently flashing a warning.

Before we continue with the analysis, there is one important caveat to provide in relation to the CAPE. In Shiller's own words, "The CAPE was never intended to indicate exactly when to buy and to sell. The market could remain at these valuations for years." In fact, Shiller penned a piece for the times more than a year ago noting that the CAPE Ratio had reached worrisome levels.

Are Investors Sailing Into Cape Fear?

The key point to Shiller's weekend article in the NYT is that the CAPE Ratio is currently above the 25.5 level. There are two reasons why this may be noteworthy from a long-term perspective.

First, according to Shiller, the average reading for the CAPE Ratio since 1900 has been... survey says... 15.21. The low end of the range has been about 5, a level that was seen in the early 1920's and 1930's. In more recent times, the low seen in 1982 was near 7 and the low in 2008 was about 13.

In looking at more than a century of data, the high end of the range for the CAPE prior to the 1990's had been the extreme move seen in the roaring 1920's. And if one excludes the spike to 34 during that period, the high-water mark was more like 23-25 until the mid-1990's

The second key point that Shiller makes is that the CAPE Ratio has only been higher than the current level three other times in history: 1929, 2000, and 2007. Yikes.

History shows that in all three prior instances, the stock market moved higher BEFORE a bear market ensued. But... the bear markets the followed such lofty levels of the CAPE were some of the nastiest on record.

For example, in the 1928 example, the S&P 500 moved higher for nearly a year before succumbing to the Crash of 1929. In 1996, stocks moved higher for more than two years before the technology bubble bear began. And in the 2007 example, the market moved higher for 45 months after the CAPE first reached the worrisome levels.

In addition, it is worth noting that since 1995, the CAPE ratio has spent the majority if the time either at or below 25.

The Key Takeaway

In short, Shiller's main point is this, "...we should recognize that we are in an unusual period, and that it's time to ask some serious questions about it."

Next we will explore several more variations on the P/E ratio as well as several other valuation indicators in order to get a good feel for the data on the subject.

Publishing Note: After spending an inordinate amount of time on airplanes this year for business, it is finally time to take some R&R. My wife and I are traveling through Iceland, England and Scotland for the next two and one-half weeks. Thus, I will publish reports only as time permits or as conditions warrant.

Turning To This Morning

The news flow overnight has been positive. First and foremost there is word that Russia and Ukraine have come to an agreement on the Russian convoy of 280 trucks carrying humanitarian aid trying to enter the Ukraine. In addition, foreign ministers from Russia, Ukraine, Germany, and France made "some progress" in talks over the weekend to resolve the Ukraine/Russia crisis. In response, global markets as well as futures in the U.S. are nice shade of green in the early going.

Pre-Game Indicators

Here are the Pre-Market indicators we review each morning before the opening bell...

Major Foreign Markets:
    - Japan: +0.03%
    - Hong Kong: +0.00%
    - Shanghai: +0.55%
    - London: +0.78%
    - Germany: +1.41%
    - France: +1.17%
    - Italy: +0.79%
    - Spain: +1.07%

Crude Oil Futures: -$0.80 to $96.55

Gold: -$7.40 at $1298.80

Dollar: lower against the yen and pound, higher vs. euro.

10-Year Bond Yield: Currently trading at 2.374%

Stock Indices in U.S. (relative to fair value):
- S&P 500: +10.69
- Dow Jones Industrial Average: +88
- NASDAQ Composite: +19.79

Thought For The Day:

Never attribute to malice that which can be explained by ignorance.

Current Market Drivers

We strive to identify the driving forces behind the market action on a daily basis. The thinking is that if we can both identify and understand why stocks are doing what they are doing on a short-term basis; we are not likely to be surprised/blind-sided by a big move. Listed below are what we believe to be the driving forces of the current market (Listed in order of importance).

      1. The State of the Geopolitical 'Issues'
      2. The State of Fed/ECB Policy
      3. The Level of Interest Rates
      4. The Outlook for U.S. Economic Growth

The State of the Trend

We believe it is important to analyze the market using multiple time-frames. We define short-term as 3 days to 3 weeks, intermediate-term as 3 weeks to 3 months, and long-term as 3 months or more. Below are our current ratings of the three primary trends:

Short-Term Trend: Neutral
(Chart below is S&P 500 daily over past 1 month)

Intermediate-Term Trend: Moderately Negative
(Chart below is S&P 500 daily over past 6 months)

Long-Term Trend: Positive
(Chart below is S&P 500 daily over past 12 months)

Key Technical Areas:

Traders as well as computerized algorithms are generally keenly aware of the important technical levels on the charts from a short-term basis. Below are the levels we deem important to watch today:

• Key Near-Term Support Zone(s) for S&P 500: 1900(ish)
• Key Near-Term Resistance Zone(s): 1960

The State of the Tape

Momentum indicators are designed to tell us about the technical health of a trend - I.E. if there is any "oomph" behind the move. Below are a handful of our favorite indicators relating to the market's "mo"...

Trend and Breadth Confirmation Indicator (Short-Term): Neutral
Indicator Explained

Price Thrust Indicator: Negative
Indicator Explained

Volume Thrust Indicator: Negative
Indicator Explained

Breadth Thrust Indicator: Neutral
Indicator Explained

Bull/Bear Volume Relationship: Moderately Positive
Indicator Explained

Technical Health of 100 Industry Groups: Neutral
Indicator Explained

The Early Warning Indicators

Markets travel in cycles. Thus we must constantly be on the lookout for changes in the direction of the trend. Looking at market sentiment and the overbought/sold conditions can provide "early warning signs" that a trend change may be near.

• S&P 500 Overbought/Oversold Conditions:
        - Short-Term: Moderately Oversold
        - Intermediate-Term: Moderately Oversold
  
• Market Sentiment: Our primary sentiment model is Positive .

The State of the Market Environment

One of the keys to long-term success in the stock market is stay in tune with the market's "big picture" environment in terms of risk versus reward.

Weekly State of the Market Model Reading: Neutral
Indicator Explained

Looking For Guidance in the Markets?

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All StateoftheMarkets.com Premium Services include a 30-day money-back guarantee!

Wishing you green screens and all the best for a great day,

David D. Moenning
Founder and Chief Investment Strategist
StateoftheMarkets.com
President, Heritage Capital Research
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Positions in stocks mentioned: none

For up to the minute updates on the market's driving forces, Follow Me on Twitter: @StateDave (Twitter is the new Ticker Tape)

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The opinions and forecasts expressed herein are those of Mr. David Moenning and may not actually come to pass. Mr. Moenning’s opinions and viewpoints regarding the future of the markets should not be construed as recommendations. The analysis and information in this report and on our website is for informational purposes only. No part of the material presented in this report or on our websites is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed nor any Portfolio constitutes a solicitation to purchase or sell securities or any investment program. The opinions and forecasts expressed are those of the editors of StateoftheMarkets.com and may not actually come to pass. The opinions and viewpoints regarding the future of the markets should not be construed as recommendations of any specific security nor specific investment advice. One should always consult an investment professional before making any investment.