By Andrew Mickey
The recession is over! GDP grew at a 3.5% clip between July and September. Wall Street’s fortunes seemingly turned around overnight. But with the rally reminding everyone how fragile it is, are the boom times really here again?

One of the world’s best investors thinks it will seem that way for a while, but - that could be bad news for the markets. Here’s why.

World’s Great Investor Turns Bearish
Six months ago almost no one believed in the rally. Unemployment was still on the rise. The economy was still contracting. The housing market, despite all kinds of incentives for buyers, ground to a standstill.

There were no fundamental reasons for stocks to rally. There were, however, a few technical reasons.

The combination of low expectations and trillions of new dollars pumped into the system would create a run in whatever asset class was on the rise. Once stocks broke out in March, the hot money would chase them back to reasonable valuations and beyond.

Back in April we proposed the Dow hitting 10,000. It seemed a bit unrealistic at the time, but given the situation, anything could happen. We weren’t the only ones who saw it that way though. One of the most successful investment managers in the world, Jeremy Grantham, saw it similarly.

Now, Grantham considers the market 25% overvalued and is taking some money off the table and you must understand why.

Frustrating Times Ahead
In his most recent quarterly letter (a must read for any investor), he brought up one very important point (emphasis mine):

The 1Q 2009 Quarterly Letter, by the way, said “in a [S&P 500] rally to 1000 or so, the normal commercial bullish bias of the market will of course reassert itself, and everyone and his dog will be claiming it as the next major multi-year bull market.”

Well, now it’s happened precisely that way, and you should not believe them! As we have demonstrated to our clients in earlier cycles, earnings estimates in particular merely follow the market up (not the other way around, as one would hope). So it is a law of nature that strong estimates will abound after a major market rally.

The earnings and economic growth estimates in such cases are usually throwaways. But the economic data next year will indeed look strong.

The irony may well be that just as nine months of weak economic data this year has been accompanied by a very strong market, so the strong economic data next year is likely to be accompanied by a weak stock market.

Think about that for a second.
Most everyone isn’t quite calling for a “multi-year bull market,” but everyone seems to agree the rally has been fueled primarily by aggressive monetary expansion (money printing) and hopes of a recovery.

Now that the masses have realized that, no one is willing to bet against this rise and many more are jumping on board. Meanwhile, the economic data continues to improve (today’s GDP growth numbers were the most positive yet) and the market’s have started show some genuine weakness.

Aside from today’s sharp rise, the markets have climbed in anticipation of good news ahead rather than on good news. As a result, we can conclude they’ve reached the dangerous point of expectations, which may be too high.

So what’s going to happen when that good news comes?
As we know, when expectations are great, the risk/reward situation turns upside down.
If the news is really good, the markets may hold up or even go a little bit higher. If the news is not good, they will falter - quickly.
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