The old sailor's rhyme is quaint, but true.

If you see red sky in the west as the sun sets, a storm is moving away from you. If the eastern sky is red as the sun rises, look out – trouble is coming your way.

The rhyme holds true as a weather forecasting tool because of the way storms move through the atmosphere. That's what the red sky is: moisture and particles in the atmosphere, a possible storm system in the distance.

A version of the rhyme has been around for thousands of years. The biblical version appears in the book of Matthew. Jesus is criticizing the Pharisees and says, "O ye hypocrites, ye can discern the face of the sky; but can ye not discern the signs of the times?"

Investors are like that sometimes, too. They're wrapped up in predicting the next bull or bear market. They don't ask whether stocks – which are just pieces of a business after all – are priced for an adequate return or not. (It's "not" these days.) Like the Pharisees in the book of Matthew, investors try to discern the face of the sky, but can't discern the signs of the times.

I want to give you a tool, a way of looking at the overall market that will hopefully supplant the ubiquitous bad habit of trying to predict whether it'll go up or down in the next few days, weeks, or months.

I've found what I believe is the best way to establish a rational expectation about stock valuations over the next five to 10 years. If you stick with this tool and forget about predicting the market's ups and downs, you'll do much better than the traders likely to get whipsawed badly in the next few years.

You'll find the tool below, in my version of a graph created by Kevin Tuttle of Tuttle Asset Management. I found the original graph in a presentation by my friend Vitaliy Katsenelson of Denver-based Investment Management Associates. Vitaliy wrote a good book called Active Value Investing.


The chart doesn't show you bull and bear markets... It shows you all the bull markets and sideways markets from 1900 to 2006. (Nevermind the bear market of 1929-1932. It's the exception to the historical rule.)

So forget about bear markets. And forget about bull markets for several years. The only rational expectation for the next several years is a sideways market, just like the ones you can plainly see between every bull market on the chart.

On the bottom of the chart, you'll find changes in the price-to-earnings ratio of the market. Notice how the valuations fall over the life of a sideways market.