Weekly Note - February 21, 2024

 Please see this page for descriptions of the language used to discuss the MRI:


This note discuses a) current market conditions, b) why there is historical precedent for high stock valuations we are experiencing, and c) an article about pessimistic views of the markets. Sections a and b have been revised for clarity and updated to reflect current statistics (highlighted in yellow).  Section c is new this week.  

A. Current Market Conditions 

The positive long-term trend of the stock market continues. The Macro MRI is in the upleg of its cycle, moving to the 39.1th percentile of levels since 1918 as of last week, up from the 38.6th percentile the prior week. This is a relatively low level and suggests that the positive long-term trend of the DJIA can continue for some time. This marks 8+ weeks of consistent movement higher – a level of consistency that did not exist last year.

The Exceptional Macro is also present. Last year, this very important indicator shifted erratically between being present and not, a pattern that has rarely occurred over the last 100+ years. It has been consistently present for the last several weeks.

The Micro MRI, which tracks the short cycles of market resilience, has been in the downleg of its cycle the last several weeks. As of last week, it was at the 37th percentile of levels since 1918, making a rapid drop from the 81st percentile three weeks prior. A ten-point drop per week is a typical pace. Over this same period, DJIA stock prices have not experienced dramatic and have even moved higher, which is the expected behavior only when the Exceptional Macro MRI is present (as it is now). Thus, the market action of the last month has been consistent with normal market behavior from the perspective of the MRI.

If the Micro MRI downleg continues at its recent pace, it will reach a low level in its historical range, say, the 20th percentile, in the next few weeks. It will then soon shift to the upleg of its cycle. At that time, we are likely to have all three of the MRI indicating market resilience. If the conditions do indeed evolve in this way, the DJIA may then mover higher more quickly.

As I have discussed with many users over the last few weeks, we were more defensive in January than the algorithms have called for. We wanted to confirm that there is indeed greater stability in the Macro and Exceptional Macro MRI considering the high current stock market valuation levels. We have seen a sufficient level of stability and, as the section below describes, high valuation levels appear to be common in similar historical periods. Thus, our portfolios are becoming more aggressive. If these trends and conditions continue, we will hold less Box #2 Cash and have higher target weights in the DJIA- and NASDAQ-linked ETFs toward the end of February or in early March.

B. Historical Precedents for High Stock Valuations Ratios 

A remaining concern from the 2022/23 period has been high stock valuations. The stock price declines of 2022/23 were not deep enough for important valuation metrics such as Price-to-Earnings and Price-to-Book ratios to decline meaningfully. Valuation ratios have remained stubbornly well above their average levels since 1997, the earliest year for which we have data for the DJIA’s valuation metrics.

Over the last several months, we have evaluated cycles of market resilience that are much longer than the multi-year cycle of the Macro MRI. These might be called “Mega cycles” and are clearly identified by our recently-developed drivers of risk tolerance. Mega cycles began in 1942, 1958, 1970, 1982, 1997, 2009, and 2022 (the current one).

We evaluated the Price-to-Earnings ratio for the S&P500 stock index (which has more Price-to-Earnings ratio history than does the DJIA) compared to various segments of the Mega cycle. Over the first roughly 4 years of the Mega cycle, the Price-to-Earnings ratio of the S&P was significantly higher than it was in other portions of the Mega cycle. This suggests that investors are inherently more optimistic during the first segment of the Mega cycle. During the first four years, the Price-to-Earnings ratio of the S&P 500 starts high, moves higher as prices move higher, and then drops as higher corporate earnings occur.

This pattern would explain why high valuation levels have persisted. If the historical pattern continues, high valuation levels could remain elevated for several more quarters. This implies that high valuation levels alone may not produce a drop in DJIA prices.

The most recent Mega cycle began in 2009. It was preceded by a 53% decline in the DJIA. The DJIA did not experience a drop of that magnitude prior to the beginning of this cycle. The most recent similar Mega cycle began in 1997. It took two-and-a-half years for prices to peak after the beginning of that cycle. If that cycle is relevant to this one, it is likely to be a few quarters before prices peak. There was a great deal of anxiety about high valuations in the late 1990s, just as there is now.

The MRI are currently moving in a manner consistent with this longer-term outlook. If the MRI diverge from this outlook, we will follow the MRI.

The impact of this research is that we will be more tolerant of high valuation ratios in determining Box #2 Cash levels and the ETFs included in the portfolios.

C. Pessimistic Views

I am aware of the concerns voiced by well-respected investment professionals described in this article: 

I believe the views have merit and I feel similar emotions. However, market conditions are not currently right for a major decline. Current conditions are most consistent with a market weakness through the first week of March, followed by greater market resilience. Current market behavior is consistent with this view.  

Should conditions change and indicate greater market vulnerability, we will trade outside of the regular trading schedule.