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The big question for investors at the moment is whether the 9-year old bull market has finally come to its inevitable conclusion or is it just a “pause that refreshes?” 

While the optimistic “hope” is that this is just a pause within a continuing “bull market” advance, from a money management standpoint getting the answer “right” is vastly more important to long-term investing outcomes.

The easiest way to approach this analysis is to start with the following basic premise:

“Bull markets are born on pessimism, grow on skepticism, and die on euphoria.” -Sir John Templeton

Take a look at the chart below which is Robert Shiller’s monthly data back to 1871. The “yellow” triangles show periods of extreme undervaluation while the “red” triangles denote periods of excess valuation.

Not surprisingly, 1901, 1929, 1965, 1999, and 2007 were periods of extreme “euphoria” where “this time is different”was a commonly uttered phrase.

What about today? Is this another period of “euphoria” or are investors still maintaining enough “skepticism” to fuel the bull market further? Unfortunately, there is little evidence investors are “skeptical” of much of anything right now.

“However, for now, there is little doubt the bullish bias exists as individuals continue to hold historically high levels of equity and leverage, chasing yield in the riskiest of areas, and maintaining relatively low levels of cash as shown in the charts below.”

But the “euphoria” of individuals is not just solely related to the stock market, but to the whole economy as well. (The chart below is a composite index of the University of Michigan and Census Bureau measures.)

So, why shouldn’t there be “euphoria?”

The stock market has been surging for the last 9-years, unemployment claims are at the lowest levels in more than 30-years and the housing market seems to be firing on all cylinders.

What’s not to love? But that’s the point.

Bull Markets Die Of Euphoria

The reason that bull markets die of euphoria is that market prices, particularly in the “momentum” stage of the investing cycle, are based on the assumption the current cycle will continue into perpetuity. Earnings, the economy, sales, etc. will continue to expand in a linear fashion…forever.

Since the economy, as well as virtually everything in life, is cyclical, it is only logical that eventually the disappointment of those assumptions sparks the beginning of the next bear market cycle.

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