"The stock market is almost magical because it always leads the economy. It goes down long before the economy drops and then heads higher long before the economy rebounds. It always has." --Kenneth L. Fisher

INVESTORS HAVE BEEN SELLING BUT HAVEN'T YET DECIDED WHAT TO BUY (September 25, 2015): If you look at the details of fund flows during the last several months, then you will discover that there have been net outflows from many funds of U.S. risk assets. This includes most U.S. equity and U.S. bond funds. As more and more time passes from the all-time peaks for many U.S. equity indices, investors are progressively realizing that the likelihood for additional gains is less than the probability that we have begun what could eventually become a full-fledged bear market. The S&P 500 reached its highest point of 2134.72 on May 20, 2015, which was more than five months ago.

Investors hate to tamper with the status quo if they are comfortable with it, so very few people sold near the spring highs. In recent weeks, there have been notable outflows especially on days when U.S. equities have been declining. The more that time passes and additional lower highs are registered for the S&P 500, the Nasdaq, the Russell 2000, and similar indices, the more that people will realize that their portfolios are losing money rather than making money. Since the losses have been modest overall, these outflows haven't nearly approached the record withdrawals which were made during the first quarter of 2009. However, there has been a notable total decline in the money committed to U.S. risk assets, while the amount of money in safe deposits including money market funds has surged in recent months.

One interesting observation is that, prior to the recent climb in the popularity of safe time deposits, these had reached all-time low levels relative to the amount of money invested in riskier assets. It is likely that, obtaining only around one percent interest or less on their bank accounts and near zero in their money market funds, many investors were encouraged to shift into far more speculative alternatives. They convinced themselves, with the able assistance of financial advisors, that they were nearly as safe in high-dividend blue chip U.S. stocks or high-yield corporate bonds as they were in the bank. In reality, they have been taking enormously greater risk, because most of these assets lost more than half their value during their respective bear markets of 2007-2009. However, most advisors politely didn't bring up this inconvenient fact, and most people would rather not think about what is possible while focusing instead on what is ideal.

Now that reality has slowly begun to reassert itself, investors have been moving back into time deposits--but haven't yet taken more than a tiny percentage of this money and invested it in other assets. Historically, whenever there is a recent surge in safe time deposits, most of the money ends up being reallocated into securities which are perceived to contain greater upside potential. The only exception tends to be near the very end of a bear market, when risk assets are plummeting and investors are frightened into safety at any cost. Since we are far from such a situation today, asset reallocation usually means chasing after whatever has recently been climbing the most in percentage terms. If 2015 ends with a net loss for most U.S. equity and bond funds, then those funds which have enjoyed net gains will stand out noticeably among a sea of red. Other investors look for whatever has rebounded the most from its recent bottom, or for various kinds of moving average crosses and other signals. Therefore, whichever assets outperform from now through the end of 2015 are likely to be especially visible and to receive increasingly positive media, analyst, and advisor coverage. The persistence of such upbeat discussion will be accompanied by strong inflows.

So far, there haven't been any sectors which have featured many such standout assets. However, this could change soon, because there is such a huge disparity between the world's most overpriced assets and the most undervalued ones. The list of overvalued securities includes many U.S. stocks and bonds and global real estate. The most compelling bargains can generally be found among commodity-related and emerging-market assets which in many cases have been trading at lower prices than during their worst levels of 2008-2009. Because they are so inexpensive, they can gain enormously in percentage terms and yet remain far below their respective peaks from the first half of 2008 or in many cases from April 2011. If this happens, then they will be able to continue to gain dramatically until the final months of 2016 or the early months of 2017.

It is too early to say whether this kind of activity will occur or not, although historically most U.S. bull markets end with a period of rising inflationary expectations. It is rare for the economy to go into a recession without first experiencing an inflationary binge. During the most recent bear market of 2007-2009, we had a sharp and unexpected inflationary climb for roughly one year from the summer of 2007 through the summer of 2008. Since literally a hundred central banks worldwide including the U.S. Federal Reserve are eager for higher inflation, we are likely to get exactly what they want. Wage inflation has been moderately accelerating in the U.S., while prices have been generally slower to follow suit. Most investors are continuing to moderately sell their previous favorites, while sitting on the fence in indecision about what to do with the money. If you follow the fund flows during the next few months, you are likely to learn a lot about what will happen for another year or more.

There are supporting clues from the media, which have become less enthusiastic about U.S. assets but continue to generally favor them because they appear to many to be the only game in town. Most news articles regarding commodities or emerging markets are gloomy, especially when there have been recent price declines for anything in these sectors. It appears that precious metals and the shares of their producers may already have bottomed, while energy producers are possibly following suit while emerging markets are mostly bringing up the rear. If all of these are able to outperform, then especially with the best-known U.S. benchmark indices continuing to struggle, investors will begin to take notice of the top-performing securities and will become increasingly eager to own them.

The financial markets have always been a paradox, in which more people are eager to buy something after it has doubled than before it has done so. It is surely the same this time, so most people won't actually participate until it is too late to enjoy the lion's share of the potential percentage gains. If an asset goes from 10 to 50, then buying it at 20 might seem to surrender only one fourth of the profit since 20 is one fourth of the way from 10 to 50. However, the gain from 10 to 50 is 400% while the increase from 20 to 50 is 150%, so you actually give up 5/8 of the total profit instead of just 1/4. The financial markets are inherently geometric rather than arithmetic, which is why it works out this way. The key is that those who buy before a rally end up gaining far more than those who wait until a rebound has been "confirmed". Also, there is really no such thing as confirmation; whenever something has allegedly established a new uptrend, it often first suffers a sharp short-term correction to punish those who were tardy in jumping aboard the bandwagon.

Tax tip: If you own shares or funds which are trading near multi-year bottoms and you are a U.S. resident, you can take advantage of their currently depressed prices if these assets are in your 401(k), 403(b), SEP-IRA, Keogh, traditional IRA, or other non-Roth retirement account. You can convert these shares from your account to a Roth IRA and pay taxes based upon their present low valuations. As these eventually rebound, all future gains will be completely tax free. In the event that these shares don't recover but end up retreating further in price, you can choose to undo your conversion, which is known as a recharacterization. You can then wait at least 30 days, or until the following calendar year--whichever is later--and then convert them again. There is no limit to how many times you can repeat this process and there are no income or other restrictions in making such conversions and recharacterizations, as long as each recharacterization is done on or before October 15 of the year following the date when the conversion had been done. It's like being able to go back in time and "unbuy" something which doesn't go up in price. It's heads you win, and tails you also win. Unfortunately, I do not know of an equivalent strategy which is permitted in any other country besides the United States.

Disclosure: In August-September 2013, and at various points during 2014-2015, I have been buying the shares of emerging-market country funds whenever they have appeared to be most undervalued. Since June 2013, I have added periodically to funds of mining shares--and more recently energy shares--especially following their most extended pullbacks. I have also been accumulating HDGE whenever U.S. equity indices are near their peaks; HDGE is an actively-managed fund that sells short U.S. equities. I believe that U.S. assets of almost all kinds have become dangerously overvalued. From my largest to my smallest position, I currently own GDXJ, KOL, XME, COPX, SIL, HDGE, GDX, REMX, EWZ, RSX, GLDX, URA, IDX, GXG, VGPMX, ECH, FCG, VNM, BGEIX, NGE, PLTM, EPU, TUR, SILJ, SOIL, EPHE, and THD. In the late spring of 2014, I sold all of my SCIF which had briefly become my fourth-largest holding, because euphoria over the Indian election was irrationally overdone and this fund had more than doubled. I have reduced my total cash position to roughly 3% of my total liquid net worth in order to increase my holdings in the above assets. I sold all of my SLX by acting whenever steel insiders were doing likewise. I also sold all of my FCG but I have been repurchasing it following its recent collapse because there has been intense buying by top corporate insiders of companies which produce natural gas. I expect the S&P 500 to eventually lose about two thirds of its recent peak value, with its next bear-market bottom occurring within several months of October 2017. The Russell 2000 Index and its funds including IWM have only modestly surpassed their highs from the first week of March 2014, while the Russell Microcap Index (IWC) marginally surpassed its zenith from March 6, 2014. The S&P 500 Index set a new all-time high on numerous occasions during the same period, and may have completed its final top for the cycle at 2134.72 on May 20, 2015. This marks a classic negative divergence which previously occurred in years including 1928-1929, 1972-1973, and 2007. Those who have "forgotten" or never learned the lessons of previous bear markets are doomed to repeat their mistakes.