Why Bitcoin’s Bull Market Isn’t Over Yet

 

On October 3rd, I had the pleasure of joining Maurizio Pedrazzoli Grazioli’s podcast for the second time. We picked up right where we left off from our previous conversation—when we called the bottom of Bitcoin on April 8th—and once again, we explored some bold bullish scenarios that, at the time, were far from obvious. Fast forward to today… and it turns out, we nailed it again. Watch it here:

https://www.youtube.com/watch?v=ORxzAytzuxk&feature=youtu.be

 

Sincerely,

Manuel Blay

Editor of thedowtheory.com

 

Why Today’s Stock Market Valuations Are Not Excessive: Liquidity, Capital Accumulation, and the Repricing of Risk

How liquidity and rising wealth explain today’s high valuations in the stock market

 

Introduction

Many market commentators warn that stock valuations are dangerously high, pointing to elevated price-to-earnings (P/E) ratios and market cap-to-GDP levels as evidence of a bubble. These warnings often rely on outdated benchmarks. What was considered expensive fifty years ago isn’t necessarily expensive today.

Two structural forces have redefined what counts as “normal” valuations. Today’s levels are not irrational but the natural outcome of two powerful trends:

1. The persistent expansion of global liquidity.
2. Raising capital stock per person has pushed down the natural rate of interest.

Together, these forces have changed the equilibrium level of valuations. A Price-to-Earnings ratio of 20 was considered expensive 50 years ago, but now it can be a good value.

Liquidity growth doesn’t just provide more money to invest; it fundamentally alters risk perception, reduces systemic risk fears, and creates a “risk-on” environment in which investors are willing to pay more for future earnings.

Furthermore, a nearly continuously growing stock of capital per person has reduced discount rates, which further encourages higher valuation multiples.

Misconceptions About Liquidity and Valuations

Many analysts argue that liquidity is “neutral” for valuations. Their reasoning typically takes two forms:

– Liquidity simply inflates earnings. When liquidity increases, prices, sales, and company earnings grow accordingly. Based on this reasoning, valuation metrics like the P/E ratio should remain unchanged because higher stock prices only indicate higher earnings. Therefore, liquidity would affect the “E” in the P/E ratio, but not the “P.”

– Stock market capitalization-to-GDP ratios can’t increase because liquidity inflates GDP. Critics also point to market capitalization versus GDP, arguing that liquidity affects both equally. If GDP is higher due to inflation caused by abundant liquidity, they contend that the market cap-to-GDP ratio should stay stable since both the numerator (market cap) and the denominator are influenced by liquidity.

While intuitive, these arguments miss a crucial point: liquidity not only fuels nominal growth but also changes how risk is priced. It drives a repricing of assets, lifting valuations independently of GDP or earnings growth.

Liquidity as a Valuation Multiplier for the stock market.

Liquidity is more than a measure of money in the system. It is a structural driver of asset pricing. When the growth of global money supply outpaces real GDP, surplus capital competes for a limited pool of assets. This competition raises prices and pushes valuation metrics higher.

The chart below shows the year-on-year percentage change of the S&P 500 compared to global M2 (money supply) over the past 10 years. We see that although the S&P 500’s annual performance might be above or below M2’s yearly growth, they tend to move in lockstep. The S&P 500 lags 6-12 months behind M2 growth, with a correlation ranging between 0.35 and 0.4. The most recent reading suggests that the stock market is neither too overextended nor too depressed. 

Illustration 1: Source https://en.macromicro.me/charts/101057/Major-Central-Bank-M2-Money-Supply-YoY-vs-S-amp-P-500-amp-NASDAQ-100-YoY  Accessed on 9/2/2025.

How does this astounding correlation between liquidity and stock market performance come about?

The key mechanism behind liquidity’s effect on valuations is its ability to alter risk perception.

Abundant liquidity acts as a cushion against systemic risk. Crashes and severe bear markets often emerge from liquidity traps or credit shortages, where even solvent entities cannot secure funding. These crises create downward spirals, forcing investors to demand steep risk premiums. In contrast, liquidity-rich environments do the opposite:

1. They reduce systemic risk fears. Investors recognize that abundant liquidity minimizes the likelihood of financial meltdowns, thereby lowering the perceived risk of holding equities and other risk assets.
2. They compress volatility expectations. High liquidity levels reduce the probability of market dislocations. Lower expected volatility drives higher valuations because investors are willing to pay more for future cash flows when risks feel manageable.
3. They improve market functioning. Deep liquidity allows distressed assets to be absorbed quickly, reducing contagion risk. This stability encourages long-term investors to remain fully invested, adding further upward pressure on prices.
4. They encourage a search for yield. With abundant liquidity and low interest rates, investors shift from cash or bonds into equities, boosting demand and driving multiples higher.

This is why liquidity expansions have an asymmetric effect: they push valuations higher much faster than they push GDP or earnings. They change investor psychology and pricing models, making equities and other risk assets appear safer relative to their historical risk profile.

The chart below plots M2 (x-axis top) vs. the PER (y-axis). We observe that M2 tends to grow exponentially as every doubling of M2 occurs in less time. The linear regression shows that the higher M2, the higher the PER.

 Illustration 2: Correlation M2 and the S&P500 performance.

And what happens to the stock market when liquidity increases so much that its annual growth rate exceeds that of the real GDP?

When the U.S. M2 annual growth exceeds annual real GDP growth, equities deliver much stronger returns. When GDP growth outpaces M2 growth, the stock S&P500 stagnates or declines. This shows that liquidity does not merely raise nominal stock market earnings or GDP; it reshapes the market’s willingness to pay for those earnings.

Jim Paulsen’s research captures this dynamic as he shows in this chart:

Illustration 3: Correlation between excess liquidity and the S&P500 performance.

I quote Jim Paulsen:

“[s]ince 1960, for all quarters when real excess annual liquidity growth was positive, the forward 1-quarter average annualized S&P 500 total return was a robust 15.97% compared to a forward 1-quarter average annualized S&P 500 loss of -6.08% for quarters when real excess liquidity was negative. Moreover, during quarters when excess liquidity was negative, the S&P 500 index suffered forward 1-quarter total return losses nearly 50% of the time compared to only 22.6% of the time when real excess liquidity was positive.”

As an aside, as of this writing (early September 2025), Jim Paulsen’s observation is bullish for the US stock market.

Historical Perspective: Liquidity Traps and Crashes

Market history shows that major financial crises, such as the Great Depression, the 2008 Global Financial Crisis, and the 2020 COVID-19 crash, were triggered or amplified by liquidity shortages. When liquidity dries up, credit channels seize, systemic risk skyrockets, and investors demand steep discounts for risk assets.

Conversely, periods of abundant liquidity not only support valuations but also act as a stabilizing force. In the post-2008 era, unprecedented central bank liquidity injections not only prevented systemic collapse but also ushered in a decade-long bull market. This underscores that liquidity doesn’t just follow market cycles; it shapes them.

But there’s a catch. Markets can become “hooked” on easy liquidity, making them vulnerable to sharp pullbacks if it suddenly dries up. That’s why timing indicators matter: they help us ride the wave when liquidity flows freely and protect us when the tide turns.

Rising Capital per Capita and the Decline in Natural Rates

While abundant liquidity helps push higher values, another crucial factor is the growth of capital per person.

As economies become wealthier, capital becomes more plentiful, leading to lower natural interest rates. By “natural” interest rate, I mean the interest rate free of inflation that would typically prevail in a given economy without central bank interference. The Austrian School of Economics has excellent insights into the natural rate of interest.

Interest is the cost of capital. If capital is scarce, the natural interest rate will rise. If it becomes abundant, like the price of everything, its rate will decline. This is why wealthy countries have lower interest rates than poorer countries. Lower interest rates result in higher valuations for stocks (PER).

A proxy for the capital stock per capita is GDP per capita, which I will use for the rest of this article.

I created the chart below that shows the relationship between GDP per capita and PER. I used the ETF representing each country as a proxy for its stock market. The x-axis displays GDP per capita, and the y-axis displays PER. The linear regression line clearly indicates that the higher the country’s GDP per capita, the higher the PER.

The correlation between a country’s wealth and its PER is noteworthy:

Illustration 4: Correlation Between Wealth per Capita in several countries and Valuation Multiples

The chart above has a Pearson correlation coefficient of 0.64, which is high, implying that a 2x richer country tends to have a 1.4 P/E points higher valuation (based on the fitted slope).

But things get even more interesting when we focus on the USA. The USA has continually grown richer in inflation-adjusted terms, which means a higher real GDP per capita.

Illustration 5: Correlation Between US inflation-adjusted GDP per Capita and Valuation Multiples

Higher capital, measured by GDP per capita, also contributes to higher valuations in the USA. GDP inflation-adjusted has risen from the 1960s to today, as has the PER.

A lower natural interest rate resulting from increasing GDP directly boosts valuation multiples: when future earnings are discounted at a lower rate, their present value rises. Comparing current valuation levels to those of the 1970s or 1980s ignores this structural change. In a world with abundant capital, it is rational—not speculative—for investors to pay higher prices for each unit of earnings.

How much of the PER expansion is due to liquidity and how much to growing GDP per capita?

So far, we have examined how both liquidity and rising GDP per capita influence stock market valuations. An attentive reader might wonder whether we are conflating these two variables, as both affect the price-to-earnings (P/E) ratio. It is essential to separate and isolate the impact of each factor on P/E expansion.

Using AI, I conducted an in-depth analysis to separate the effects of liquidity growth from those of increasing GDP per capita. How much has each factor contributed to expanding PERs?

Since 1960, there has been a rise in the trailing P/E of about +12.7 points in total.

• Of that, roughly +4.1 points came from GDP per capita growth.
• Roughly +8.6 points came from more liquidity (real M2).

Therefore, for Trailing P/E, liquidity accounts for about twice as much of the increase as GDP does, but both are important.

Roughly, an increase of +1% in GDP per capita results in an increase of about +0.032 PER points.

And an increase of +1% in real M2 brings about a rise of +0.046 PER points.

Conclusion: Implications for Investors.

For investors, this analysis changes how valuations should be read. High P/E ratios or market cap to GDP levels are not automatic warning signs. They reflect powerful forces: abundant liquidity, low natural interest rates, reduced systemic risk, and a growing capital base. Valuations must be measured against these realities rather than clinging to outdated rules that label a P/E of 10 as cheap and 22 as expensive.

In this vein, just as a P/E ratio of 22 is often seen as expensive, many investors claim that another indicator points to extreme overvaluation: the Buffett Indicator, which compares the total stock market value to the country’s GDP. At first glance, its current reading (red line in the chart) appears extreme and seems to confirm that a crash is inevitable. That conclusion is wrong. Adjusting the Buffett Indicator for M2 gives a very different picture. The blue line at the bottom of the chart shows the ratio has hardly moved, from 0.13 in 1978 to 0.14 today.

During the dotcom bubble, the liquidity-adjusted indicator reached 0.296 in March 2000, more than twice today’s level. Seen through the lens of liquidity, current valuations are elevated but nowhere near the excesses of that era.

 

In today’s global economy—wealthier, more liquid, and better-capitalized than at any time in history—high valuations are not signs of irrational exuberance but reflections of structural forces that have permanently shifted the baseline for pricing risk.

However, should liquidity suddenly contract and/or GDP per capita shrink (due to misguided economic policies, war, etc.), then we should brace ourselves for a market crash, which is precisely what happened in the 1930s depression: Shrinking liquidity and real GDP. Market timing will be the lifeboat in such a case.

Sincerely,

Manuel Blay

Editor of thedowtheory.com

 

Unlocking the Power of Market Timing

 Featured in Technically Speaking (August 2025) and spotlighted by Investopedia, this article delivers hard evidence for smarter investing, proving how disciplined timing can cut drawdowns and drive lasting success.

 “The Power of Market Timing” is an essential read for anyone serious about achieving lasting financial success. Featured in the August 2025 issue of Technically Speaking, it offers conclusive evidence that market timing is critical for long-term survival. The data challenges the traditional buy-and-hold approach and makes a compelling case for adopting strategies that cut drawdowns and outperform.

https://tinyurl.com/mrwy3w54

A heartfelt thank you to CMT Association Editor Alayna Scott and Curriculum Director Louis Spector for showcasing my work.

Sincerely,

Manuel Blay

Editor of thedowtheory.com

When fundamental Indicators Break Down, Price Still Leads

 

The LEI and yield curve missed the mark. Price action and margin debt told the real story, and we listened

 

 For decades, investors leaned heavily on two stalwart indicators: the yield curve and the Leading Economic Index (LEI). These tools had an almost mythic reputation for signaling recessions and bear markets.

However, as Jim Paulsen recently pointed out in his piece “Broken Relationships,” both once-reliable guides have lost their mojo.

The LEI, a composite of ten economic indicators, including the yield curve and consumer sentiment, has historically done a remarkable job warning of recessions and, by extension, bear markets. Whenever LEI momentum turned negative, stocks usually followed suit. That pattern held for over 60 years.

Until it didn’t.

As Paulsen notes, the LEI correctly signaled the 2022 bear market. But then something broke. While the S&P 500 bottomed in October 2022 and entered a new bull market, the LEI continued to decline, as shown in the chart below.

That’s unprecedented. The result? Many investors missed out, trapped in recessionary narratives despite clear upward price action.

The other broken relationship Paulsen highlights is bond vigilantism. For years, market watchers feared that rising government deficits would push bond yields higher. That relationship, too, has unraveled. Since the mid-1990s, higher deficits have often been accompanied by lower real bond yields. The vigilantes, if they ever existed, are now ghosts, although I suspect they are about to make a comeback.

As with the LEI, we did not fall prey to the ominous message displayed by a persistent inverted yield curve that lasted more than one year and accompanied the birth of the October 2022 bull market.

What does this mean for us?

It means we must respect history, but we should never become enslaved to it.

At TheDowTheory.com, we’ve monitored the LEI and yield curve throughout 2022, 2023, and 2024. We acknowledged their warnings, but we didn’t fall prey to them. We followed the trend. We followed price action. And it paid off.

Our equity curve says it all:

Here’s the simple truth: price action trumps everything.

If the market is in a bull phase, you act accordingly. You don’t wait for every economic signal to align.

You invest first and ask questions later. That’s not recklessness, that’s responsiveness.

Another indicator we’ve placed consistent trust in and which continues to deliver is margin debt. Unlike surveys or lagging macro data, margin debt reflects real conviction. When investors borrow to increase exposure, it signals bullish sentiment backed by capital. And margin debt trends—especially when rising in tandem with the market—are rarely wrong. Margin investors tend to be more sophisticated, and their actions offer insight that many overlook.

Subscribers to TheDowTheory.com have seen this in real-time. While others fretted over broken indicators, we tracked margin debt trends, watched price action, and remained focused. The result? We did not miss the Bull market that started in October 2022, nor did we miss the one that began on April 8th, 2025.

This is not to say we ignore classic indicators. We keep them on the radar. But when push comes to shove, the final arbiter is the market itself. Fundamentally-based indicators come and go. Narratives break. However, price action is always right.

Sincerely,

Manuel Blay

Editor of thedowtheory.com

 

Two new interviews with Alessio Rastani on Youtube

 

Once again, I was invited by Alessio Rastani to join him in two new videos.

Since I was in my 80% work, 20% vacation mission across Europe, I was not fully equipped, so we had to do an “unplugged” performance. No fancy mic, nor headphones or hi-end speakers on my end. Just my reliable laptop, and the Real Madrid F.C. t-shirt I was wearing at the moment.

We recorded both videos on July 4th.

In the first video, we said that a pullback was looming on the near-term horizon, and I explained why. Spot on!

I also explained that I remain long-term bullish.

https://www.youtube.com/watch?v=qPMQ6SX4BMo&t=786s

 

 

The second video focuses on Bitcoin and the influence of Ethereum in generating signals for Bitcoin. The principle of confirmation works.

https://www.youtube.com/watch?v=GGsp6VNkT_g

 

 Sincerely,

Manuel Blay

Editor of thedowtheory.com

 

 

The Real Problem with Buy & Hold—and What to Do About It

 

Three Smarter Ways to Cut Drawdowns Without Killing Performance

The core issue with buy-and-hold investing is simple: drawdowns. Big ones. They may be inevitable, but that doesn’t make them any less damaging—both financially and psychologically.

To address this, many investors turn to buffered ETFs, hedging with puts, or going short. But there’s a catch: these protective strategies come at a steep price. They can sap performance, require precise execution, and often fail to provide consistent results when you need them most. In short, they cost money—and they typically dilute returns.

Another response is to do… nothing. Just “weather the storm.” After all, markets always recover—right? That’s the theory. But in practice, this approach falters for two big reasons:

1. Most investors drastically overestimate their tolerance for drawdowns. It’s easy to say, “I can handle a 50% drawdown”—until it actually happens. In real life, drawdowns don’t just hurt portfolios—they wreck confidence and cause people to bail out at the worst possible moment.
2. The U.S. market is the exception, not the rule. Historically, the S&P 500 has shown an incredible ability to bounce back from deep losses and hit new highs. But many global markets haven’t. European indices, for example, have gone decades without recovering prior peaks. And who’s to say the U.S. will remain exceptional forever?

So what are investors left with?

You can either:
✅ Weather the storm and risk getting crushed by a massive drawdown,
or
✅ Hedge and accept the long-term performance drag that comes with it.

Neither option is ideal.

That’s why I believe in a third path—one that sidesteps both the psychological toll of deep drawdowns and the performance drag of costly hedging. It’s built on three key pillars:

🔹 Market Timing

When properly executed, market timing is one of the very few strategies that can reduce drawdowns without incurring the costs of hedging—and often with the added benefit of outperformance. While it’s often dismissed, the reality is that trend-following and timing approaches, when grounded in data, are both cost-efficient and effective. My Composite Timing Indicator is a key example of such an approach.

The chart belows show the outperformance and marked drawdown reduction of the Composite:

🔹 Sector Rotation

By dynamically shifting exposure across asset classes or market sectors, investors can sidestep underperforming areas and adapt to changing macro conditions. It adds another layer of diversification that helps absorb shocks without relying on expensive hedges. My Dow Theory + High Relative Strength strategy harnesses this principle by combining market timing with exposure to leading sectors.

🔹 Quantitative Stock Selection

Finally, stock picking doesn’t have to be guesswork. Using a quantitative approach to select stocks with a proven statistical edge enhances the overall resilience and return potential of the portfolio—especially when combined with timing and sector rotation. Portfolio 123 is the tool to build a systematic stock selection process that filters out obvious “lemons” and tilts toward winners.

This is an example of what can be achieved with a good stock picking strategy:

No strategy is perfect, but combining these three elements can provide a robust framework to reduce drawdowns, sidestep prolonged underperformance, and—most importantly—keep you in the game.

Because the real risk isn’t just losing money.
It’s losing the discipline to stay invested when it matters most.

Sincerely,

Manuel Blay

Editor of thedowtheory.com

Bull market for the gold and silver miners ETFs (GDX & SIL) signaled on 6/2/25

 

Overview: The precious metals landscape has turned very bullish. Gold, silver, platinum, and even base metals like copper are trending strongly upward. GDX and SIL are no exception to this new trend.

General Remarks:

In this post, I provide an in-depth explanation of the rationale behind employing two alternative definitions to evaluate secondary reactions.

SIL refers to the Silver Miners ETF. More information about SIL can be found HERE.

GDX refers to the Gold Miners ETF. More information about GDX can be found HERE.

A) Market situation if one appraises secondary reactions not bound by the three weeks and 1/3 retracement dogma.  

As I explained in this post, the trend was signaled as bearish on 12/18/24.

In a clear case of whipsaw, no sooner had the bear signal been triggered than GDX and SIL staged strong rallies, breaking above their previous bull market highs (5/9/25 for SIL at 42.57 and 4/16/25 at 51.91 for GDX). This confirmed breakout occurred on 6/2/25 and shifted the trend to bullish.

The chart below displays the most recent price action. The brown rectangles show the last secondary reaction. The blue rectangles display the rally that set up both ETFs for a primary bear market signal. The red horizontal lines highlight the secondary reaction lows, whose breakdown signaled the end of a primary bear market, and the blue horizontal lines indicate the last recorded primary bull market highs, whose breakup signaled a new primary bull market. The grey rectangles show a bounce that did not meet the time requirement to qualify as a secondary reaction.

So, the primary and secondary trends are bullish.

B) Market situation if one sticks to the traditional interpretation demanding more than three weeks and 1/3 confirmed retracement to declare a secondary reaction.

As I explained in this post, the primary trend was signaled bullish on 3/13/25.

The most recent current drop did not last at least 15 trading days on both ETFs, so there was no secondary reaction, and hence, no change of trend.

Higher confirmed highs have reconfirmed the primary bull market.

Therefore, the primary and secondary trends remain bullish.

Recent price action underscores the importance of analyzing the trend using two alternative time frames. The shorter-term time frame was whipsawed, while the longer-term time frame remained bullish throughout.

Sincerely,

Manuel Blay

Editor of thedowtheory.com