In past articles we have described secular bear trends as long periods of time (typically greater than a decade) where average Price to Earnings Ratios (P/E) are contracting based on deteriorating investor expectations (see here and here). These secular trends have almost nothing to do with trends in earnings but are based entirely on investor sentiment, with the average P/E ratio being an ultimate measure of investor sentiment on a secular level.
But there is another, more tangible and current feature of this cyclical bull trend that can also be used to help determine if equities are still stuck within a secular bear environment or are beginning a new long-term bull cycle; that is feature we refer to as the market's theme.
A missing and troubling feature about this cyclical bull trend in equities since early 2009 is that it has lacked a bullish major economic theme. Historically, every cyclical bull market has been driven by an underlying theme that carries on from the start of the bull cycle to its eventual demise. Typically this theme is a driver of, and defines, the bull cycle to a degree that impacts the behavior of economic sectors or market capitalization indices, resulting variances in sector rotation model.
For example; from 1982 to 1987 the market theme was large cap conservative dividend stocks. Investors had just experienced a period of high interest rates throughout the late 1970's, and very poor equity returns. Most investment portfolios consisted of primarily income producing bank CD's at historically high yields. But as yields peaked in 1982 investors could no longer just roll over their CD's and maintain their income. Because the stock market was reaching new highs, investors started tip toeing into the equity market, but playing it safe with blue chip companies that had a solid history of rising dividends. The theme for that time was the exodus from CD's into dividend paying blue chip equities.
After the 1987 crash and recovery period into 1989 the theme began to slowly shift toward more risk. When investor's realized that even the great crash of 1987 did not lead to another Great Depression, and equities recovered rather than continuing lower, it slowly emboldened investors to consider riskier assets.
Once the 1990 -1991 recession resulted in only a minor and brief setback in the equity markets, (Because investors were still comparing events to the 1970's, a 20% thirteen week decline was a non-event.) the desire for risk seemed to leap forward as investment houses began to preach that higher risk meant higher reward and used models that conveniently dated back to absolute low of 1974 to prove it. As a result, small-cap stocks were the leading asset class for the first time in more than a decade with a 46.1% return in 1991, followed by an 18.4% return in 1992 and an 18.9% return in 1993. The "high risk equals high return" theme evolved toward International stocks in 1993, aided by a tenfold increase in the number of international equity mutual funds to facilitate investors' new interest. The Morgan Stanley Emerging Markets index jumped over 65% in 1993. The theme for the bull cycle that ended with the "stealth bear market" of 1994 (those who were in the business that year might remember trying to explain that frustrating mantra) was investor faith in 'higher risk equals higher reward' for the first time since the secular bull started in 1982.
In the latter half of 1990's the bull cycle had an evolving theme around "the age of technology" and, of course, the Internet. The theme of the bull cycle(s) from 1994 to 1998's correction and then 1998-2000 was, as we all know, the Internet and its technology revolution. The leading technology stocks outperformed the market throughout this period.
The bull trend from 2002 to 2007/2008 was also very simple to identify. It was primarily the evolution of emerging market economies and their demand on commodities, along with a secondary theme in energy and "peak oil" as the growth of emerging markets depletes the world supply of oil. Both of these themes persisted throughout the unusually long five-year bull cycle. The energy and peak oil mantra was so hard to kill that energy stocks continued their bull trend into May of 2008, even though the S&P 500 peaked seven months earlier, in October, '07. From the 2002 market low through the end of the bull cycle, equities based on Materials, Emerging Markets and Energy were sector leaders.
So, what has been the theme of the bull trend from the 2009 low? Some investors may make an argument for gold as a theme. However, rising gold prices are not a driver of equities, which is a prerequisite for the definition of a theme that drives a bull trend. In fact, the correlation between gold and the broad market equity indices is relatively low. It may be more accurate to consider gold as a sub-theme, just as energy was to emerging markets during the last bull cycle. Still, because most investors who are or have accumulated gold are doing so as a hedge against the potential long-term impact of current monetary policy, on the surface, it seems that the basis of the affection for gold is an underlying fear. Fear is opposite of and contradicts the optimistic nature of most bull cycle themes.
Is the Federal Reserve and global central bank intervention, the new monetary policy, the theme of the current underlying bull trend? Evidence suggests that it was QE1 that put the brakes on the 2007-2009 market meltdown. It also shows that QE1's demise preceded the 21% correction into the October, 2011 low, and that it was the anticipation of QE2 that launched the 32% rally into the April, 2012 high. Here, too, it was the anticipation of the expiration of limited quantitative easing that precipitated a meaningful decline into June of 2012. Once again, the decline in the equities indices was stalled by the expectation of, and then the announcement of renewed monetary intervention in the form of QE3. When we consider that there are no other industry or sector economic drivers of this bull cycle, it seems that evidence clearly supports the idea of central bank intervention in the equity markets, and the new monetary policy as being the theme of bull cycle that started in early 2009.
In secular bull trends, the interwoven cyclical bull markets each have their own underlying theme based on an optimistic outlook. It can be optimism toward a new technology or innovation, global economic forces (i.e. emerging markets), a new outlook on wealth management or any of a number of themes that influence investor demand and drive the bull cycle higher based on higher expected valuations. The Federal Reserve and its new monetary policy is a crutch meant to support equities until the long-term outlook improves and growth is once again self-sustainable. It's also a monetary policy that is as unsustainable as current economic growth would be without it. This is not a theme that secular bull trends are made of, history is likely to show it as no more than a bridge of artificial support that holds equity prices at unjustifiable levels as the indices mark time in-between bear market cycles.
When the next secular bull market begins, it will be based on an optimistic outlook, a new vision of the future being better than today. And, as is always the case with a new secular bull trend; as the optimism spreads throughout the investment community, so will average valuations. It's the expansion of those valuations (P/E ratios) that drives equity prices higher.