The single most effective marketing message the investment industry has peddled over the past three decades is, ‘In the long term the share market always goes up.’
My retort to this widely accepted statement is, ‘But will it go up in my investment timeframe?’
In 2006, global share markets ran hot. Three straight years of 20%+ gains. In the same year, my weekly newspaper column, ‘The Big Picture’, began warning readers the good times wouldn’t last and a prudent investor should consider taking profits.
Such talk in the midst of a boom was met with a fair degree of derision.
With hindsight my warning of an impending market correction was too early and the longer the market performed, the easier it was to dismiss my viewpoint. In 2007, share markets posted another 20%+ gain. The lesson learned from this experience is it can be very lonely waiting for a trend to fully express itself. Self-doubt is a constant companion.
My belief in the secular market model remained steadfast and in 2008/09 global share markets behaved as expected.
So what is the secular market model? In simple terms it’s the old ‘two steps forward, one step back’ principle.
The following chart of the Dow Jones index from 1900 to present highlights the staircase pattern of the market’s advancement.
Secular Bear Markets are the periods when the lines are flat. Conversely, Secular Bull Markets are the ascending lines.
The century old market pattern is a cycle of undervalued to overvalued and back to undervalued. This is a well-established market pattern.
The following two charts courtesy of Crestmont Research show how this valuation cycle occurs.
But before we take an in-depth look at the charts, I need to give you some mathematical background.
One of the main valuation tools in the share market is the Price to Earnings (P/E) Ratio. The long-term P/E average for the market is around 16.
If you’re not familiar with P/E’s, here’s a simple example…
If a company earns $1 Billion, its fair price based on the long-term P/E average is $16 Billion ($1 Billion earnings x 16).
While the long-term average is 16, there are times in the market’s history when the P/E is higher than average (periods of boom and exuberance) and times when it’s lower than average (periods of bust and gloominess).
This high, medium and low range are what constitutes the average.
The first chart is the P/E ranges for the various Secular Bull Market periods. NOTE – all Secular Bull Markets have started with a below average P/E (the green shaded area between 5 and 10). The blue line (representing the latest Secular Bull Market from 1982 to 1999) started with a P/E around 8 and finished at a stratospheric 48.
To put this into context, a company earning $1 Billion in 1982 was valued at $8 Billion (8 times). Even if the company didn’t increase earnings over the next 17 years it was valued at $48 Billion in 1999. This was an eye-popping 600% increase in value simply due to investor exuberance.
By comparison all previous Secular Bull Markets overshot the average and went into the 20 to 25 range. The 1982 to 1999 boom (fuelled by the greatest credit bubble in history) took valuations into nosebleed territory.
The other side of the boom coin is the bust. The following chart traces the retreat of P/E’s from their boom time highs. These periods are Secular Bear Markets.
Again let’s focus on the blue line – the market P/E from 2000 to 2012. After the P/E peak of 48 in 1999/2000 it has gradually reduced down to around 20.
A stagnant period of share values is a result of falling P/E’s being offset by rising company earnings.
For example a company earning $1 billion in 2000 was valued at $48 Billion. The company could increase earnings to $2.4 billion (140% increase in earnings) but with a P/E of 20, the company is still valued at $48 billion ($2.4b x 20).
The combination of shrinking P/E’s (from extreme highs to lower lows) and rising earnings is why markets trend sideways for an extended period of time – usually 10 to 20 years. Waiting for this trend to play out requires patience.
(NOTE: The blue line – current Secular Bear Market – has only retreated into the 20 to 25 range. This is where all previous Secular Bull Markets have ended and started to fall. The unwinding the 1982-1999 period of excess has been prolonged due to a manic desire by central banks to pervert the natural course of markets.)
If history repeats itself, the current Secular Bear Market is a long way from finished.
We know markets never ascend or descend in a linear fashion. They zig and zag.
In looking at previous secular markets, there are several phases (zigs and zags) that contribute to the overall performance of the market.
The following chart of the 1966-1982 Secular Bear Market shows there were 9 phases – 5 negative and 4 positive – over the 14 year period. Collectively the fall and rise of these phases resulted in a zero sum game.
Whereas the 1982-1999 Secular Bull Market consisted of 7 phases – 4 positive and 3 negative. The positive phases were so strong they make the 1987 ‘crash’ look like a mere speed bump. The credit bubble took hold in the 1990′s and its influence is clearly evident from 1990 to 1998.
The following chart of the S&P 500 index shows the current (2000-present) Secular Bear Market has had 4 distinctive phases so far – 2 negative and 2 positive.
Based on history it is hard to conclude global share markets are set for a continued run upwards – here are a few reasons why:
- P/E ratios remain high compared to previous Secular Bear Markets
- There does not appear to be enough negative phases to create investor fatigue – market sentiment is still too bullish. Previous Secular Bear Markets have completely sapped investor confidence.
- The current recovery (from Mar 2009 to present) is now four years old and has recorded a 100% gain. This is well above average.
- The current recovery (2009 to present) has been strongly aided by unprecedented Central Bank intervention. This intervention is producing far less bang for the printed buck.
- The 1982 to 1999 Secular Bull Market was the greatest period of extended performance in share market history due to the greatest credit bubble in history. The US Federal Reserve has aggressively fought the bursting of this bubble – firstly, in 2001 when Chairman Greenspan provided cheap credit to fuel the US housing bubble and secondly, in 2009 Chairman Bernanke provided cheap credit to investment banks to repair their balance sheets and support asset (shares, bonds and commodities) prices. Defying gravity can only last for so long.
The centrifugal force created by wholesale money printing has kept markets spinning to date. The recent market wobbles suggest the energy force is waning. The Secular Bear Market’s gravitational pull is set to take the market through its next down phase.
Vern Gowdie
Contributing Writer, Money Weekend
From the Port Phillip Publishing Library
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