After I read a Seeking Alpha article Saturday, exclaiming that we are now in a secular bull market, with apologies to the bears, I could not help but present the counter-argument to what seems to me to be an overly optimistic outlook built upon shaky assumptions.
I apologize to the bulls (and the author) in advance, but this is what makes a market after all. The past four years can clearly be defined as a robust cyclical bull market, but I don't see this period as being any different than what we saw from 2003 to 2007, which was another cyclical bull market within the confines of what has been a secular bear that began in 2000. With respect to terminology, secular implies a long-term trend (up or down) that moves in the same direction over an extended period of time, generally agreed upon to be five years or more. A secular bull market is one that meets these conditions, while also exceeding previous all-time highs on a recurring basis. We have yet to meet these conditions, as the S&P 500 (SPY) has not breached its record high set in 2007, much less doing so on a recurring basis. At this point, it seems to be presumptuous, if not misleading, to declare a new secular bull market in equities.
I encourage investors to read this excellent synopsis of what a secular bear market is in an article written by Barton Biggs in April 2007, in which he considers whether or not the secular bear market that began in 2000 was coming to an end. It was clearly not, but his pragmatic approach to both bull and bear arguments at that time, circumventing the typical biases that we see from Wall Street, is pertinent today when trying to answer the same question. He states the conditions required to begin a new secular bull -
"How long it will be this time before stocks begin a true, new secular bull market is very difficult to guess. The conditions for such a renaissance are that money should be cheap and amply available, the debt structure should be deflated, there should be pent-up demand for goods and services, and, probably most important, stocks should be clearly cheap based on absolute valuation measures. Today, money is cheap and available, but the other conditions are not in place. United States equities are far from cheap, but, considering the level of interest rates and inflation, they are not expensive, either."
I would argue that we see similar circumstances today. Money is clearly cheap, but ample only for corporations and individuals with excellent credit. Debt structure is far from deflated, as the very modest decline in private sector debt is being more than offset by the surge in public debt. Household debt-to-income ratios remain at multi-decade highs. There is no measurable evidence of pent-up demand for goods and services, with personal consumption still near record levels as a percentage of GDP. We are still in the midst of a deleveraging cycle. As for valuations, equities are no longer cheap, but clearly not expensive given current interest rates and inflation.
Examining P/E multiples and earnings yields as a guide to determining the continuation of a trend is a worthless exercise. It might be useful at extremes, but that is not the case today. Expectations for earnings are also poor guides because they are always too optimistic at cyclical highs and too pessimistic at cyclical lows. What we can confirm is that during previous secular bear markets, we have always seen valuations decline to the levels at which the preceding bull market started, so today we would need to reflect upon the period from 1982 - 2000. In the early years of that secular bull market the S&P 500 traded at a multiple of just 10 times earnings. We are currently at approximately 15 times on a trailing 12-month basis with what appears to be an extremely optimistic consensus expectation of $111 in earnings on a forward basis.
In regards to investor sentiment, it is not as reliable an indicator as it used to be, simply because individuals have been largely marginalized by the dominance of institutional trading activity. Additionally, it is what investors actually do, rather than what they say, that is relevant. On that front, I don't question the public's gradual reluctance to participate in the stock market's slow creep higher over the past couple of years. I sympathize with it. I also don't view it as pent-up demand that will fuel the market higher over the next couple of years in what has been coined the "Great Rotation." Quantitative easing is not an investment strategy, unless it produces the improving economic fundamentals on a sustainable basis that its facilitators assert it will. It has not. The majority of Americans do not see the economic improvements they hear and read about impacting their personal situations. At the same time, the public is understandably distrustful of the financial markets, viewing stock market gains as an unreliable source of wealth accumulation over the long term, considering the lack of legitimate financial reforms that have been enacted since 2009. The market still operates as the same derivative-driven casino void of transparency that led to the last crisis.
This doesn't mean that the investing public has missed out on the huge gains of the past four years. To the contrary, the public has done exceedingly well investing in the bond market as an alternative up to this point, as the risk-adjusted returns have been competitive with equities. There are obviously risks associated with investing in the bond market today that were less consequential in years past, but this is another discussion.
Have we just come out of the starting blocks to a new secular bull market, or are we simply crossing the finish line of another cyclical bull? I imagine the question will be answered during the course of 2013, but the preponderance of evidence combined with objective thinking should lead investors to be cautious at this juncture. I think the further one stands back from the cyclical bull market, the clearer the landscape becomes. From my perspective, we are still in the early innings of what is likely the third and final stage of the secular bear market that began in 2000, which has been defined by a trilogy of debt accumulation at the corporate, consumer and government level. It has been the deleveraging process that inevitably follows, serving as the countervailing force to growth, which has kept the stock market range-bound since 2000. The cyclical bull runs within this secular bear have been fueled by monetary and fiscal initiatives designed to inflate asset prices and stimulate debt-induced consumption.
We are now embarking on the deleveraging of government. This process needs to reach the point where deficits are narrowing, debt-to-GDP levels are stabilizing, the economy is no longer dependent upon fiscal stimulus, and financial markets are free from central bank manipulation. Until then, the bear will not release the stock market from its grip, and it will remain mired in the wide channel it has occupied over the past 13 years. I think the question long-term investors need to be asking themselves today, especially those that have been putting new money to work in the stock market at record levels over the past 13 weeks, is do they have enough conviction in what they must deem to be a new secular bull to ride out what could be a cyclical bear during the course of 2013. If not, they should be looking for a better risk/reward opportunity.
Additional disclosure: Lawrence Fuller is the Managing Director of Fuller Asset Management, a Registered Investment Adviser. This post is for informational purposes only. There are risks involved with investing including loss of principal. Lawrence Fuller makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by him or Fuller Asset Management. There is no guarantee that the goals of the strategies discussed by will be met. Information or opinions expressed may change without notice, and should not be considered recommendations to buy or sell any particular security.