'You can't buy it now," a value style fund manager said to me last week, referring to the Australian sharemarket. "There is no earnings growth and the thing is up 20 per cent in six months."
The S&P/ASX 200 has actually kept rallying over the past week and is now up a whopping 23 per cent since the current surge ignited back in early June 2012.
In technical terms we are in a cyclical bull market now that the market has breached the 20 per cent level. The bears, though, will say it is just another sharp rally in a secular bear market that has been in train since the market topped on November 1, 2007.
So should you buy the sharemarket now that it has motored 23 per cent higher in six months or have you missed the whole thing and is it better to wait for a pull-back?
Previous cycles indicate the size of any correction in prices in the short term will be minor and there is still some joy left for investors in 2013.
The value-based fund manager was correct about the market rising despite a lack of earnings growth. In fact, from the time the S&P/ASX 200 Index started its rise back in June until now, analysts have wound back earnings forecasts circa 6 per cent.
The market's price-to-earnings ratio, the benchmark measurement of valuation, has risen some 30 per cent from around 10.3 times forecast earnings to 13.3 times.
For most, this phenomenon of rising prices and falling earnings is counter-intuitive. Conventional wisdom says that earnings must grow to justify share price gains. However, the reality is that not only have 2013 financial year earnings been wound back recently, but so have 2014 earnings, which will become the focus of professional investors once the February reports are out of the way.
The chances are that while there will be few hand grenades this reporting season, the outlook will be uninspiring and earnings for 2014, if anything, will be wound back again in the coming months.
So how can the market keep rising in this environment?
Recent research from Goldman Sachs explains what is going on. During periods of loosening monetary conditions, such as we are now experiencing, the PE ratio tends to expand and will continue to do so until monetary conditions tighten. The size of the expansion varies from cycle to cycle. However, Goldman's analysis reveals that the market PE typically climbs all the way up to north of 15 times forecast earnings.
Even after the latest 23 per cent rally and 6 per cent earnings downgrades the market PE sits at around 13.4 times.
In other words the S&P/ASX 200 can still rally about 12 to 13 per cent before it reaches the customary PE level when monetary policy is being loosened.
In the rally of 1993, following the secular bear market from 1987 to 1992, the market PE soared to almost 18 times.
However, these lofty levels are unusual and we have to assume that once the market PE hits 15 times, stock prices will require earnings growth to keep rising.
That takes the S&P/ASX 200 to around 5500.
If we now turn our attention to the first surge out of the bear market, a rise to 5500 is not fantasy.
That kind of gain would mean the index would have moved about 39 per cent from the start of the rally in June 2012. In previous secular bear markets a similar pattern played out. Following the 1929 crash and subsequent bear market into the early 1930s, in the first year of the new bull market the All Ordinaries Index rose 37 per cent from late 1931 to late 1932.
From the low in September 1974 to September 1975 the All Ordinaries rallied 42 per cent and from November 1992 to November 1993 the jump was a staggering 46 per cent.
So the average performance of the sharemarket in the first year after a secular bear market has been just under 42 per cent. This makes 5500 very achievable.
So if we can make 5500 on the S&P/ASX 200 Index some time during 2013, what happens next? History tells us the market can continue to climb for some months, but then it will come to a halt. The most common party-pooper has been the emergence of tighter monetary policy. In other words the Reserve Bank of Australia starts to increase interest rates and the Federal Reserve in the US stops printing money.
This type of selloff won't be the gut-wrenching one we experienced in 2008, but it will take many months to play out.
The signs we are rapidly moving to this point in the cycle are starting to emerge.
Sentiment from all sectors of the community has turned positive during December and January after multiple years of hopelessness. Retail stockbrokers are reporting a surge in retail interest and equity fund managers are being forced to buy shares because of increased inflows.
We are some time away from dangerous sentiment levels, but we must remember that a new bull market will behave like a car that has not been started for some months. It will lurch forward before stalling. Eventually the engine will flush out the sludge and run smoothly.
At the moment we are only in the first lurch of an emerging secular bull market.