Analysis paralysis often strikes the hardest when you least expect it.

As investors we’ve all gone through periods of time when we feel that our investment strategy seems invincible one day, just to find out that it looks totally inadequate the next day (week or month). Any one single piece of economic data (I.e. jobs data) may send our investment spiraling and add to the uncertainty. Then what?

Interestingly enough, it’s when we feel most confident – should we dare say cocky – about what we are doing, that our hard-earned money is most vulnerable. A thief comes unannounced in the night, so do unexpected down-turns.

Without being vindictive or rosy-eyed, it helps to evaluate how we’ve felt at major pivotal market junctures in the past and how unexpected and painful the inevitable reality turned out to be.

Going back ten years, investors were literally shocked when the tech-bubble (NYSEArca: XLK) collapsed and dragged the Nasdaq (Nasdaq: ^IXIC) in particular, along with the Dow Jones (DJI: ^DJI) and S&P (SNP: ^GSPC) to much lower than expected lows.

Just a few years later, in 2005 the idea of ever-rising real estate prices (NYSEArca: IYR) started to lose momentum. Moreover, falling property prices proved to be like a malignant cancer that spread slowly, but surely, into all segments of the economy.

Initially, financial institutions (NYSEArca: XLF) were crafty enough to create profits, as we now know, out of thin air and offer a false sense of security and even rising profits. No later than 2008, however, financials had lost their luster and started to crumble like an old cookie.

The ONLY way to get better!

Looking back for the past ten years, ask yourself, did you own more than your fair share of stocks in 2000 and 2007? Were you overexposed to real estate when you shouldn’t have been? Did you sell in 2007 or buy in 2009? Is your net portfolio balance (without new contributions) today higher than it was ten years ago? Are you closer to retirement?

Those are tough questions to ask, but only by asking them and truly evaluating what you’ve done and what you can do better, will give you a shot at financial safety.

More of the same

Just a few short weeks ago, investors’ felt the same euphoria about stocks and the economy as they once did in 2007 and 2000. In fact, investor sentiment numbers – bullish sentiment that is – had reached levels not seen since 2007, 2000 and 1987 (depending on which piece of data you use).

History is blatantly honest about what tends to happen when investors get too confident. Furthermore, history is more than just past events; it has always provided a pattern for those willing to see it (more about that in a moment). In fact, history is as predictive in its prophesying power as it is relentless in its execution of judgment.

Not so subtle clues

On January 15th, 2010, two trading days before the broad market (NYSEArca: IWB), along with a select few of the secondary indexes (Nasdaq: QQQQ), rallied to its January 19th high watermark, the ETF Profit Strategy Newsletter issued the following strong admonition:

“Bullish sentiment has reached a level where it is suffocating nearly all bearish currents and undertones. The natural reaction would be, and has been by most, to conform to the trend, join the crowded trade and turn bullish. Historically, such extreme optimism leads to market declines. Even though the up-trend has lasted longer than expected, we believe that every day that brings higher prices presents a better opportunity for the bears.”

Much has happened since. All major banks’ earnings reports were more or less disappointing and President Obama delivered a speech and proposal designed to restrict bank’s risky operations. As the speech was delivered, the Dow kept dropping 200 points and more. 

Are financials stronger today?

Back in September 2008, the ETF Profit Strategy Newsletter branded banks (NYSEArca: KRE) and financials institutions as a “down-ward spiral with no stop-loss provision” and recommended to buy short ETFs like the UltraShort Financial ProShares (NYSEArca: SKF) and UltraShort S&P 500 ProShares (NYSEArca: SDS).

Even though we saw no fundamental improvements for any of the banks, the ETF Profit Strategy Newsletter issued a Trend Change Alert on March 2nd and recommended to load up on financial stocks (NYSEArca: VFH), the broad market, dividend ETFS (NYSEArca: DVY), and economically sensitive sectors like consumer discretionary (NYSEArca: XLY).

The rally that was to drive stocks was to be fueled by investor optimism, not by improved profitability, margin or better management. The big picture did not change in March 2009 and it hasn’t today (or has it?).

What did change temporarily is investors’ perception. In March, the major indexes had lost over 50%. No bear market moves in one linear line, there are counter trend rallies, such as the one  which has been named the biggest sucker rally in history, from 1929 – 1930. In 1930, the Dow retraced 52.7% of the initially lost points before continuing its relentless decline.

Signs of life or last gasp?

Some may remember that back in March 2009, the administration considered the financial system to be a house of cards. What has changed?

Most financial profits have come from major investment bank’s trading operations. Loan losses (aka toxic assets) are still mounting, foreclosures are rising and fewer homes are being sold. Goldman Sachs, the government favorite and new powerhouse on Wall Street, has now lost over 25% from its October high. Many consider a 20%+ drop the beginning of a new bear market. Regardless, a 25% drop at a Wall Street talent-packed, government sponsored institution, should be worrisome.

Doing the impossible

Putting a valuation price tag on the financial sector is as tough as it’s ever been. Any profits that are reported are engineered. The true value (or lack thereof) of mortgages on the books is undetermined at best and grossly overstated at worst.

Some financial institutions have no positive growth at all – that means there is no P/E ratio, the simplest measure of underlying value. Just last week, regulators shut down more banks, boosting the tally for 2010 to 13. This is in addition to the 140 banks that were closed last year. Many banks are in such bad shape that the FDIC can’t find a suitor of any sort.

For the first time in 2009, the P/E ratio for the S&P 500 constituent companies had sky-rocketed to above 100 – as high as 143. This is the highest P/E ratio ever recorded in history. As of now, the P/E ratio (based on actual reported earnings by Standard & Poor’s) is north of 80.

To put this in perspective, if you loaned money to the S&P 500 Corporations to help them expand and restore their business, it would take the average company over 80 years to pay back the loan – without interest.

Of course, projections are that earnings power will grow, thus reducing the “payback” time. But keep in mind, analysts have already projected (and the market obviously reflected) that optimistic outlook in early 2010. Actual earnings however, have not lived up to their expectations.  Projections are just that - projections - and chances are that Wall Street will have to do what it does best - revise their estimates.

You may also find interesting that all the analysts projecting strong growth now, did not see the 2008 crash coming. Furthermore, in March 2009, when stocks were actually ready to rally, analysts lowered the earnings outlook by over 20% and were proven wrong yet again. Does it really make sense to bet on a losing team?

Put your faith in facts

Rather than following the changing tides of Wall Street, it might be advisable to examine the facts that don’t change.

Historically, the stock market is always overvalued and never bottomed unless P/E ratios hit rock bottom – rock bottom is way below current levels. Based on reliable historic parameters, the stock market is grossly overvalued and not even close to a bottom.

Dividends are another measure of value. Healthy dividend yields reflect a healthy economy. Current dividend yields are anemic and offer no hope of capital preservation. The Dow measured in the only true currency – gold (NYSEArca: GLD), mutual fund cash levels, 2,000-day moving averages, and many other indicators point to the same conclusion – lower prices.

The November issue of the ETF Profit Strategy Newsletter includes a detailed analysis of all the above mentioned indicators plotted against the historic performance of the Dow Jones. A picture paints more than a thousand words, and the picture painted by these indicators is certainly worth the viewing and much more reliable than any piece of daily economic news.

Every issue of the ETF Profit Strategy Newsletter includes a detailed short, mid and long-term outlook for all major asset classes along with specific target levels and ETF profit strategies. It's time to turn analysis paralysis into profitable investment strategies.