Sustained bullishness is bearish, especially once the market starts to trend sideways. We don’t yet have that choppy sideways action on declining RSI that has been a death knell for rallies, but sooner or later it will emerge. If the market starts sidedays, this would complete the most bearish syndrome possible, though we already have a market that is overbought and overvalued, with overbullish sentiment and rising bond yields (John Hussman’s bearish syndrome that has nailed most major tops for decades).

In economic news, Q4′s negative GDP print supports the thesis that we entered a recession in the 2nd half of 2012, as leading indicators had been suggesting for months. It also comes right as the Citi Economic Surprise Index is again on the downward slope of its regular cycle, meaning surprises are more likely to be to the downside.

Overbought: S&P 500 within 3% of its upper Bollinger bands, at least 7% above its 52-week smoothing, and over 50% above its 4-year low

Overbullish: Investors Intelligence sentiment survey shows bulls above 52% and bears below 27%

Overvalued: Shiller P/E above 18 (it’s currently 23)

Rising yields: 10-year Treasury yields above their level of 6-months earlier.

This condition also appeared in 1929 (followed by a crash and 20 year bear market in real terms) and 1964 (stocks peaked in ’66 before going down 80% in real terms over the next 16 years). When stocks are overbought and overvalued, treasuries have fallen, and most investors are bullish, it is to your great advantage to eliminate market risk (sell your stocks or hedge them).

This has been one of the longer periods of inversion in recent history. Selling gold and buying platinum in equal weights when the ratio is well over 1.0 has been a dependable money-maker for patient traders, as the ratio tends to revert to well under 1.0.

Previous drops under 14 in recent years have been followed by limited upside in stocks and an increased incidence of significant declines.

This week’s action seems to be based on relief that Congress has come to terms on the budget. Never mind that taxes are going up for everyone (payroll tax “holiday” ends), and that no progress was made on spending, not even so-called “cuts” to the rate of growth.

Side note on the budget:

High inflation remains baked into the cake for the coming years, just as it appeared in the later years of the secular bear markets of the 1910s, 1930s-40s, and 1966-1982. This is not just because the government is running trillion+ deficits without end, because the Fed has tripled its balance sheet and the monetary base in just four years.

When enough bad debt has been written off for lending to start back up in earnest, the upswing of the multi-generational interest rate cycle will have severe repurcussions for the budget. The effects will be greater because the US Treasury is not taking advantage of low long-term rates, but issuing mostly shorter-term notes.

Note that I was a rare bull on Treasuries going into the last debt crisis. That is no longer the case, but I’m not necessarily bearish on them just yet.

Trader opinion gold has been very low since late October, a full eight weeks ago. Every similar instance in the past several years has been followed by a substantial multi-week rally. That said, if the bull markets in precious metals and the yen are indeed over, we should expect downtrends to become more protracted, with sentiment remaining low for longer.

Here’s a 1-year daily chart of gold:

1-year daily JPYUSD:

I’m holding to a thesis that the risk trade is topping out here as the US slides into a recession that remains largely unrecognised. Tops are rarely sharp peaks, but consist of several months of choppy sideways action during which sentiment deteriorates from giddy to nervous and the VIX picks up even before prices have fallen substantially. I view the rebound since mid-November with that context, akin to the action of April-July 2011 or pretty much all of 2007.  Last nights mini flash crash in stock futures fits into that context of a increasingly jittery market.

We’re three months from the 4-year birthday of the (presumably) cyclical bull market. It is now older than most cyclical bulls within secular bears, though the last bull phase lasted from March 2003 to October 2007, 4.5 years.

Another cyclical bear and a recession and drop in corporate earnings may finally compress multiples to the investable levels required to build a solid base for another bear market. I don’t expect this to happen quickly, though, since prices have a long way to go before we see anything that can be called historically cheap. I wouldn’t be surprised to see stocks hold at or beneath current levels for the rest of this decade as inflation creeps in towards the end and boosts earnings, as happened during the latter stages of the last three secular bear markets (roughly the 1910s, ’30s, ’70s).

Here is GDX, the gold miner ETF, which looks good technically, as well as being cheap vs. the metal itself:

A caveat here is exemplified by the coffee futures market (see recent posts), which has steadily declined since a manic high 18 months ago. Gold and silver experienced a mania around the same time, which perhaps capped their 11+ year bull run. If that is the case, a situation like the present could actually resolve not in a rally, but in a crash, as crashes may develop from oversold and bearish conditions that would otherwise be bullish. For this reason, as well as the value discussion below, I would be careful about any longs and use a stop-loss.

I still maintain that gold is overvalued relative to a meaningful basket of other assets and metrics. Today, a kilo of gold buys (or rents) you more real estate, commodities, labor, automobile, etc. than at any time in modern history, save bottoms in those respective markets and tops in the metal.

This doesn’t mean that gold can’t rally for a few weeks or months or even make a new high – it just means that doing so would make it even more historically overvalued. The time of gold being a great value has long passed. It has done a very nice job at protecting holders against the Federal Reserve’s war on savings, just like it did a good job at protecting against inflation in the late 1970s, but gold peaked prior to inflation, and today gold may peak prior to the end of Bernanke’s tenure.

I often make the point that gold is not the only hard asset. In an inflationary episode, there are many ways to play. The dollar lost 2/3 of its value from 1980 to 2000, but over that period gold lost 90% of its value when adjusted for inflation (70% nominally). As in equity investing, the price you pay determines your return. I would look for hard assets that are closer to historical lows, or at least mean values, rather than something near a high.  Distressed real estate comes to mind, or even Japanese equities.

Heck, if we get another cyclical equity bear market within the post-2000 secular bear, there will be plenty of hard, productive assets available for reasonable prices in the stock market. BTW, every episode of double-digit inflation in the US since 1900 has ocurred during the latter years of a secular bear market in equities (1919-1920, early 1940s, 1979-1982). Thanks in large part to Mish‘s explanations of the credit market, I have been a deflationist since late 2007, despite the shrill warnings of the hyperinflation crowd. There is no telling how long our own Japanese situation lasts, but we likely have at least a couple more years to go.