Howdy folks. How was your weekend? It appeared pretty soggy for most of you. Fortunately it looks like most of the rain and crazy weather is now behind us, and the next few days should be decent ones... weather-wise anyway. For the market, I'm not so sure. Although stocks staged a pretty impressive rebound effort in the latter half of Monday's action after the early stumble, we still can't get the opening pullback off our minds. Stocks once again exposed their vulnerability, even if the sellers didn't exploit it. Knowing the vulnerability is there means the would-be bears could take their shot at any point in time in the foreseeable future, and we still contend a selloff is more a matter of "when" rather than a matter of "if." Thing is, not everyone necessarily agrees. Last week we reminded all of you readers we're open to questions and comments, and where it would be beneficial, we'll respond to them in the public forum of this newsletter. We got one such question this weekend that dovetails perfectly into something we were going to discuss today anyway. The note reads: "I do not understand your continuous predication of a big correction. You can make the charts do anything you want, but the truth is earnings continue to be above most expectations, and forward earnings also back that up. The P/E's are still relatively low, so why such nay-sayers you are? Inflation is still below the 2% level, and no indication if any big change in interest rates for the near future. Am I missing something HERE!!!" Thanks for the note. (Great question, by the way.) Though we're going to try and address each point, there's a bit of an overarching idea we want to relay first. To give full credit where it's due, though, the answer-overview isn't going to be my words. I thought John Monroe over at the SmallCap Network Elite Opportunity said it perfectly in this afternoon's edition of the EO newsletter by penning: "With the markets continuing to hover around extremely long-term expansion levels, a new options period kicking off today and rising tension in the Middle East, there's a very strong argument equities are in what could end up proving to be a very vulnerable state. I find it interesting after years of Wall Street professionals and retail investors continuing to question just how far these markets could run, many investors have recently adopted the plan stocks are simply going higher until rates rise and bond buying is curbed completely. All I can say is if it were that easy, everyone would just continue to make money hand over fist and although we've continued to see pockets of good earnings with respect to certain individual companies, the reality is gains have been very tough to come by. When you take a step back and consider some of the monstrous gains we've provided SCN EO Members with for a good part of our existence, over the last several months, the landscape has changed dramatically. Based on my experience, when that starts to happen, there's often the strong possibility of at least a mild storm ahead." To be honest, I wasn't thinking of it in the same terms John was, but I do think he's right - this isn't just a matter of assuming stocks will keep rising as long is interest rates (and therefore inflation) is low. All the factors affecting stock prices are fluid, and ever-changing, and there's more than one correct answer to the proverbial market-valuation equation. Inherently-volatile sentiment is the X-factor, which is why stocks can be so vexing at times... the market doesn't always follow an if-then pattern. Now, to the extent it can, this addresses the reader's point that tame inflation is good for the market. We agree it's good for the market. We're just not sure how good or how long it can be good for the market, because everything else is in flux.... .... like the market's valuation. The reader's question also suggests P/E levels are relatively low. This may be a point we have to agree to disagree on. While one could reasonably argue low interest rate environments justify high valuations from stocks, we've yet to find any actual empirical evidence to say this is so. Oh, there's some anecdotal evidence to very modestly suggest it (see the nearby chart), but there's no cause-effect relationship we can determine between low inflation and high valuations. Until we do find that evidence we're going to have to look at P/E levels on an absolute basis, and we're going to have to assume the current trailing P/E of 17.7 is dangerously high compared to the long-term average of 15.5. Ditto for the forward-looking P/E. Although our digging says the typical forward-looking marketwide P/E is 14.0, we've seen some sources say the norm is closer to 14.5. It may not matter either way. The current forward-looking P/E is 15.4... above even the most generous of normal projected P/E levels. With all of this being said, I want to really pinpoint my exact concern with the market and earnings growth here. Our chart of the S&P 500 with its per-share earnings and P/E ratios is the same one we always show you. Today though, I want to take a highly-detailed look at it. While we can't say the market's never been priced higher than a trailing P/E of 17.7, we can see this is the first time since the late 90's that the trailing P/E has pushed its way upwards to 17.7 when/because earnings and stocks were both on the way up. The P/E was greater than 17.7 in the early 2000's, but stocks were falling at the time. The P/E was greater than 17.7 in 2003 and 2004, but valuations were on the way down rather than on the way up then. The trailing P/E was well above 17.7 in 2009, but that was clearly an anomaly fueled by overall net losses. The point is, this is the first time in nearly a couple of decades stock prices have raced this far ahead of upward earnings growth, based on a P/E basis. It's a subtle difference, but I think an important one - investors are expecting a lot from the market here. Indeed, they're relatively expecting more from stocks here than they have in nearly 20 years in this particular situation (rising earnings and rising stocks). High expectations can be a recipe for trouble. You could make the argument the market is simply "growing into its future earnings," but I'm not so sure investors are drinking that Kool-Aid anymore. The forward-looking P/E of 15.5 is already well above the norm, and the S&P 500 is going to have to grow earnings at an average pace of 14.8% over each of the next four quarters just to reach current targets. I never want to say never, but I don't recall ever seeing the market put up such growth in the latter part of a bull market. Yes, we've seen it coming out of a bear market when the comparables were easy to top. I don't recall every seeing sustained growth that big during a mature bull market, however. Now, with most everything that matters laid out on the table, there are two final points we want to make. One of them is (and not that the reader's question even implied it), we're not talking about the development of a new bear market here. We expect this bull market to last for several more quarters. We're just looking for a correction. The upper limit for the correction we see coming would be something on the order of 10%, and a more realistic guess would be a stumble of 5% to 7%. We just need to readjust the market's valuation to something more along the lines of maybe a trailing P/E in the 16's. The other key take-away from today's newsletter is, although we appear to be logic-based and odds-based trading scientists most of the time, we know there's an art to the trading game as well... the kind of thing that you just can't quantify. And, our inner trading "artists" - trained by learning too many lessons the hard way - are just saying there's something not quite right about the current rally. I think John Monroe assessed it perfectly when he said "...over the last several months, the landscape has changed dramatically. Based on my experience, when that starts to happen, there's often the strong possibility of at least a mild storm ahead." Is it the market's valuation? Yeah, that's part of it. It's not all of it though. There's another data nugget you can't readily see on any chart nagging at me. It's the fact that the S&P 500 has now rallied 72 days without any kind of significant trip-up. Although we've seen bigger rallies than the 9.5% advance we've seen over the 70 or so past days, we've not seen a rally persist this long at any point during the past two and half years... and maybe longer. When we start breaking records, I start getting nervous. It's got nothing to do with valuations and inflation though. It's got everything to do with the market's ongoing ebb and flow. Now, not one single bit of my bearish outlook means a thing unless the S&P 500 begins to crumble and move under the 20-day moving average line, which it hasn't yet. This is why we've only talked about the possibility and its reasons to date. From an odds-maker's perspective though, it's tough to have any other expectation than a bearish one. Let me be clear about one more thing, however - any healthy correction is going to be something we see as a buying opportunity. By the way, if you're looking to combine our fundamental assessment with a more actionable, trading-oriented outlook, then you want to check out the Elite Opportunity service. We gave you a taste of what John had to say in the EO today, but the most actionable stuff - and the context - in the Elite Opportunity is what you didn't read. If you really want to be a well-rounded trader, the SCN EO is the next logical step. Here's how to get a free two-week trial , or cut and paste this link: https://www.smallcapnetwork.com/?vmpd_ckstr[click_track]=Newsletter&vmpd_ckstr_redirect=/pages/SCNEO/v1/ Oh, and one more thing.... we may have another micro cap trading idea for you later this week. We were pleased to see how well Giggles N Hugs (GIGL) moved out of the gate, as it tells us the market is receptive to high-quality small cap ideas. Be on the lookout for our overview of the stock, most likely in a morning edition of the newsletter. I doubt it will be tomorrow, but Wednesday morning is a distinct possibility.