Let’s consider two classical market valuation measures, price-to-earnings ratios and dividend yields.

You will see how this bear market, which started in 2000 with record overvaluations, accompanied by unbridled optimism, still has a lot of corrective work to do …

With a current price-to-earnings ratio of 23.39 on a twelve-months trailing GAAP earnings basis, valuations are as high as they usually get during an interim bear market rally.

Consider the dividend yield which is under two percent. Significantly below the three percent level, indicating an extremely over priced market.

Meanwhile, Exuberant Optimism Is at Dangerous Levels

Think back to the public’s emotions at the depth of the crisis in late 2008 and early 2009. It looked like the world was coming to an end.

Everybody seemed to think the stock market was a lousy place to have investments. Economists who tend to be bullish and upbeat all the time showed signs of doubt and deep concern.

Now about 18 months later the whole picture has changed dramatically!

Bullish forecasts for the economy and the stock market are back in vogue.

In fact, Investors Intelligence is telling us that 51.1 percent of stock market advisors are wildly bullish again, up from less than 25 percent during the fourth quarter of 2008.

The number of financial newsletters that are bullish is increasing in great numbers. Mutual fund managers … can’t resist the surge and are hopping on the band wagon.

The average mutual fund cash level has fallen to a mere 3.5%. At this level, the sentiment indicator has tied the record reached during the market top in the summer of 2007.

Equity put-call ratios are also falling dramatically, reaching levels not seen since 2000.

The Stock Market Is Trading in The Rarified Atmosphere of Euphoria

The market has rallied roughly 80 percent since the March 2009 low bringing valuation metrics back to dangerous levels.

Money supply growth has declined to a low ebb, while stock market sentiment is blasting ahead on low volume to unrealistic highs. The housing market is still in a mess with mass foreclosures on the horizon.

The economy is lacking real growth momentum, and new jobs mainly are being created by the government while real unemployment is far greater than 9.7 percent!

What does all this mean?

The stock market has entered the last phase of a huge low volume bear market rally off the March 2009 low. In the near future we will see the beginning of the next bear market down leg.

To further support this conclusion: The Fed is continuing to ramp up the printing presses in a vain attempt to keep the global economy on life support. The more the Fed increases the money supply the more your savings and investments are devalued.

Most of latest reported “bank” profits – some $7.2 billion – have come from active trading in the bond and stock markets.

This answers a central question many of us have been asking as the markets spiked day after day brushing off any bad news. “Who is doing all the buying and paying up for these overvalued stocks?” It clearly hasn’t been Main Street doing the investing or taking the gains.

In fact, when you look at the public sentiment polls, such as the April report from Thompson Reuters/University of Michigan’s indexed poll of consumer sentiment… its at the lowest levels in over a year. Pew’s poll on government trust topped that: It places sentiment regarding the competence of our leaders at a 50-year low.

The catalyst may be the government’s laying fraud charges on the Wall Street Banks

On April 16th the SEC charged Goldman Sachs with fraud in connection with its subprime dealings. These allegations may lead to a sharp selloff which may finally be the catalyst that begins an overdue major, market correction.

It seems likely that there is more to Goldman’s alleged double-dealing than at first blush.

This is probably just the beginning for Goldman ... and many other big banks and brokers that were deep in creating and profiting from the subprime debacle.

This looks like the beginning of a prolonged, perhaps, politically inspired witch hunt on Wall Street, possibly leading to more litigation and class-action lawsuits that stretch out for many years. Such uncertainty could easily lead to increased volatility and downward pressure on the financial markets.

The SEC has taken on a very worthy opponent… One who has not caved in and accepted a consent decree to put a stop to what could be an expensive long drawn out legal battle…

Goldman is a powerful international bank with top gun attorneys and lots of money to give the SEC a much need run for their (our) money.

The SEC has the reputation of not going after the big guys that have the capital to fight back… It could be very interesting and costly… Especially for the innocent public investor.

Considering these developments, it may be a good idea to increase your cash position now — and start rebalancing your portfolio for the sea change about to come…

Get ahead of the curve… act… don’t react after the fact… A sharp decline can wipe out a year’s worth of gains in a matter of weeks…

Take advantage of a free, confidential, second opinion in Cookeville, Crossville, Kingston or Knoxville with Bob Tonachio, CEO of Robert James & Associates. He may be contacted at 1-800-530-5700.