Is Something Really Wrong With This Market? This Is Why Secular Bull Market Trends Matter

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Includes: AGG, DIA, EFA, IWM, IYT, QQQ, RSP, SPY
by: Christopher DeMaria

Summary

Long-term secular bull markets and why they matter.

Leadership from the Dow Transportation Average.

Expecting multiple swings between support and resistance levels.

Cautionary notes.

Secular stock market graph of the Dow Jones Industrial Average

Secular Markets Click to enlarge

A secular market trend is driven by forces that could be in place for many years, causing the price of a particular investment or asset class to rise or fall over a long period of time. In a secular bull market, strong investor sentiment drives prices higher, as there are more net buyers than sellers. In a secular bear market, weak sentiment causes selling pressure over an extended period of time.

The market appears to be in the early to middle stages of a "Secular Bull Market" which, on average, can last 10 to 15 years. Some analysts contend that P/Es have not reached the range (near 10 for a valuation low reading) or coupled with a more volatile inflationary/deflationary picture to indicate the beginning of a new secular bull market. The above rationale is valid except that "true inflation", to the average consumer, certainly feels like it has been understated over previous years. Will the market listen to the CPI numbers or to what consumers are actually experiencing? Thus far, it appears to be listening to the consumer.

Although P/Es are not cheap by historical measures, which have often coincided with changes in secular market trends, the general trend for earnings still remains positive and this can be seen in the chart below:

P/E and Earnings, S&P 500 Click to enlarge

These performance charts have been provided for informational purposes only, and should not be used as the sole basis for making an investment decision. Investment decisions must be made on your own individual needs and risk tolerance. The content you gather from any performance chart is just one of the factors that should be considered before making your investment decision. Past performance is not a guarantee of future performance, and the performance of these diagrams are subject to a number of market factors that may cause the price to fluctuate.

Investopedia.com defines the earnings yield as "The earnings per share for the most recent 12-month period divided by the current market price per share. The earnings yield (which is the inverse of the P/E ratio) shows the percentage of each dollar invested in the stock that was earned by the company." When comparing the S&P 500 earnings yield to the ten-year Treasury bond yield, an investor can gain additional insight into where to allocate assets.

A prudent investor will consider the earnings yield on equities when evaluating where to position an investment portfolio. The earnings yield should be higher than the "risk free" yield on ten-year Treasury bonds in order to justify taking the additional risk of equity ownership. Conceptually speaking, a prudent investor would not be interested in equities if there wasn't a "risk premium" for assuming the additional risks of owning equities. The chart below shows that the culmination of bond yields, near historical lows, and a recovery in earnings, that began in 2009, have created an attractive risk premium for equity ownership.

Earnings Yield and 10 Year Treasury Yield, S&P 500 Click to enlarge

These performance charts have been provided for informational purposes only, and should not be used as the sole basis for making an investment decision. Investment decisions must be made on your own individual needs and risk tolerance. The content you gather from any performance chart is just one of the factors that should be considered before making your investment decision. Past performance is not a guarantee of future performance, and the performance of these diagrams are subject to a number of market factors that may cause the price to fluctuate.

Intersecting secular markets with earnings yield

The diagram below is an overlap of the secular market chart and earnings yield chart from earlier. Secular bull markets have been historically preceded by a spike in the earnings yield and also accompanied by an increase in the spread between the earnings yield and the ten-year Treasury yield.

Overlap of earnings yield and secular markets Click to enlarge

Due to the prolonged secular bear market, which lasted between 2000 and 2013, many investors are not sure how to adjust their investment style in order to enhance their returns. During the previous bear, investors had been punished for holding positions and hence conditioned to take profits quickly and move on to the next opportunity or flee to safety. If we are indeed in a secular bull market, investors will be rewarded for identifying high quality investments and holding them until the secular trend changes. This is in steep contrast with what has worked during the secular bear.

The Dow Jones Transportation Average

The Dow Jones Transportation average is beginning to exhibit some strength compared to the Dow Jones Industrial Average. This is important due to Dow Theory which was discussed the article How Can You Identify Market Turning Points?...Reloaded and any strength is welcome.

Comparison chart of the Dow Jones Industrial Average and the Dow Jones Transportation Average (08/25/2015 until 01/27/2016) diagram below.

Dow vs Transports Click to enlarge

These performance charts have been provided for informational purposes only, and should not be used as the sole basis for making an investment decision. Investment decisions must be made on your own individual needs and risk tolerance. The content you gather from any performance chart is just one of the factors that should be considered before making your investment decision. Past performance is not a guarantee of future performance, and the performance of these diagrams are subject to a number of market factors that may cause the price to fluctuate.

Multiple market swings between support and resistance levels

2016 is off to a dismal beginning and many investors are reminded of the carnage that occurred in 2008. Although there is a possibility of continued selling pressure, investors should consider that the market will likely remain range-bound throughout much of the year. Consequently, 2004 and 2005 come to mind as the Dow tested its highs and lows several times before breaking out to higher levels.

A range-bound market, similar to 2004 and 2005, would involve multiple swings between support and resistance levels as the market stores up enough energy for its next move. Active investors may consider adjusting tactical allocations and monitoring leading asset classes as the market approaches both extremes.

Cautionary Note

This is one of the more difficult junctures, that I've experienced since joining the financial services industry over 18 years ago. Many of the indicators I follow are dangerously close to turning negative and consequently, may warrant becoming more defensive. A violation of 15,666 in the Dow and 1867 in the S&P 500 would warrant a more defensive strategy. Likewise, it's important to note that a significant amount of market risk has already been released and markets will likely attempt to rebound and potentially test higher levels.

Interesting Note

September 13, 2015 marked the peak of the Shemitah, which occurs every seven years, on Elul 29 of the Hebrew calendar. It is a time when debts are to be forgiven and the land, in the agricultural communities of ancient Israel were to be given a rest. According to "The Harbinger" by Jonathan Cahn, America's two greatest financial shakings occurred on successive Shemitah years.

  • September 17 , 2001 was the beginning of the economic calamity associated with 911 and the lowering of interest rates by the Fed. September 17, 2001 fell on Elul 29 on the Hebrew calendar.
  • Likewise, September 29, 2008, marked the next big crash. September 29, 2008, also fell on Elul 29.
  • A deeper historical look into the Shemitah suggests that it may be more than just a coincidence.

Conclusion

We appear to be in a "secular bull market" and hence, any pullbacks should be considered opportunities to buy at lower prices. The transports are exhibiting strength off their recent lows and this is encouraging as the markets need to attempt to test previous highs. Despite being optimistic about the overall market, don't be surprised if there are multiple swings, testing both highs and lows, before the year end. Finally, if the August 2015 lows are violated, a more defensive approach may be necessary.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The information contained in this report or information provided does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered reliable, but we do not guarantee that the foregoing material is accurate or complete. Expressions of opinion are as of this date and are subject to change without notice. This information is not intended as a solicitation of an offer to buy or sell any security referred herein. Past performance may not be indicative of future result. Christopher DeMaria is registered with and securities offered through Kovack Securities, Inc. Member FINRA/SIPC. 6451 N. Federal Highway, Ste 1201, Fort Lauderdale, FL 33308 (954) 782-4771. Investment Advisory services are offered through Kovack Advisors, Inc. DeMaria Financial Services is not affiliated with Kovack Securities, Inc. or Kovack Advisors, Inc.