If This Is a Secular Bear Market, Where Do We Stand?

[click to enlarge]

With the exception of the Hang Seng and the Shanghai Composite, global stock market indices fell in the month of October, signaling the first month-over-month decline since February. Not even a better-than-expected earnings season and a 3.5% GDP number for the 3rd quarter could lift the markets higher, indicating that a lot of the good news had been priced in ahead of time.

It’s safe to say that the easy money in this rally has been made and that the market will have a much tougher time rising another 50%. Many are wondering whether the market highs for this year have been seen. As usual, I have no strong views about market direction in the short term, nor does my investing strategy depend on it. I think a more interesting question is: if we are in midst of a secular bear market what can history tell us about where we are now?

The data for the above chart comes from Robert Shiller’s data which uses 10yr trailing earnings, inflation adjusted to calculate the P/E ratio. As the chart above shows, there have been 3 secular bear markets over the last 100 years and I’m not saying anything shocking by suggesting that we are currently in the throes of a 4th.

The average duration of the three secular bear markets prior to the current one is 18 years with a range of 16 – 21 years. That would put us roughly halfway through a secular bear market if history is to be any guide. So if we are in fact in a secular bear market and can expect it run at least another 6 years or possibly another 11, what does it say that the current P/E ratio is 18.8x as at the end of the September 2009 quarter?

Firstly, it is above the average of the past 130 years of 16.3x. Second, it is way above levels that P/Es have traditionally hit at the end of secular bear markets. Taking an average of the P/E ratios at the end of the prior three secular bear markets gives an average of approximately 6.8x.

So what does it all mean? Well if we are only halfway through a secular bear market we can expect P/E ratios to compress significantly before all is said and done. That can occur in a variety of ways: earnings and prices may fall or prices might just stay stagnant or even rise whilst earnings rise at a faster rate. If we are indeed returning to an era of lower leverage and slower growth it would seem reasonable to expect P/E’s to come under downward pressure.

That said, it should be noted that every secular bear market in the last 100 years has been punctuated by several sharp sustained rallies and cyclical bull markets. The rising tide of the last 7 months has lifted nearly all boats, however, further gains will be more difficult to come by and thus stock-picking whilst always important, will become much more so.

Comments

[Carlos Lam:]

Good article. I think that we have a few problems now that we didn't have during prior secular bear markets, though:

* national debt + unfunded liabilities at about $117 TRILLION
* household debt to GDP at 100%
* fewer workers per retiree
* manufacturing as a percentage of GDP is less than 15%
* increased legal restrictions on mining

These facts militate for a longer than average secular bear. Indeed, I cannot see how we in America can have solid growth with so much debt overhang. Certainly, households can pay down their debt; but the federal government seems unwilling to cut spending, so I fear that it will resort to the printing press to pay back its debt in depreciated currency. Simply put, this secular bear has many structural issues associated with it that cannot be easily addressed.

Nov 02 06:03 AM

[Graham and ...:]

We're at just about the midpoint of an 18 year secular bear market, from 2000-2017 or thereabouts. The next decade will mostly be a "lost decade," but not all of it.

Nov 02 11:19 AM

[cyclingscholar:]

The three secular bear markets have been "lets try socialism, regulation and government intrusion" experiments. Right now we are halfway thru our latest flirt with socialism, which started at the end of Clinton, proceeded unimpeded with RINO GWB, and will end in a disaster crisis with our latest Anointed One. Then the stage will be set for another reagan style revolution.

Nov 02 01:39 PM

[E Nuff Sed:]

Couple of obesrvations on the P/E10 chart.
1) The compression of P/E's from top to bottom seems to be around a factor of 3 to 4.
2) We have reached this factor in March 2009.

Nov 08 03:59 PM