Secular Bull Or Bear: A Response To The WSJ

Includes: SPY
by: William Greenfield

When I pick up my copy of The Wall Street Journal, I usually don't get a chance to read it right away. As an investor that doesn't believe in efficient markets, I don't kill myself to be the most current with everything in the market, so I'm usually a couple of days behind on my reading. That's why I didn't see the article written by Tom Lauricella in the paper titled "Is Bull Sprint Becoming a Marathon?" until today.

I found it to be an easy read and quite informative. Tom takes the reader through the secular bear markets of the past and draws some parallels to the market that we have been experiencing for the last 13 years. He brings in some experts who claim that the recent rise in the markets may be the end to what has been a lackluster decade in the stock markets.

Tom notes that in every secular bear market there have been

…several things in common: They lasted at least 10 years; stock returns were below average and negative when adjusted for inflation; and valuations, as measured by price-to-earnings ratios, declined.

A falling P/E multiple essentially means investors are unwilling pay more for earnings.

During the 1968-1982 bear market, the P/E ratio on the S&P 500 fell below 10 in early 1977 and then stayed in the single digits for the next five years, according to S&P. The long-run average P/E for the S&P 500 is about 15.

As proof that we may be entering a new secular bull, Tom notes that the S&P 500's trailing 12-month P/E ratio had fallen briefly to below 10 in 2009 and that now it's around 14.4.

The article cites a few investment professionals that are wary of saying this is the end of the secular bull. As the title suggests, the question is still open, with no definitive answer.

The funny thing is that the data that Tom used to show that a secular bull might be starting is possibly misleading. Tom points out that in the last secular bear market the P/E ratio was below 10 for a significant amount of time. This statement implies that low P/E ratios are present in bear markets, but not in bulls. A look (S&P 500 P/E chart)(S&P 500 P/E table) at the late 1940s to early 50s will show that the S&P 500's P/E was below 10 from about August of 1947 until May 1952, and below 15 until some time in 1958. Yet during that time the S&P 500 returned 16.22% with dividends reinvested (S&P 500 return calculator). So, clearly a secular bear isn't the only time that can we have "low" P/E ratios.

Furthermore, if the P/E ratio fell below 10 in 2009, as Tom says (he quotes Fidelity as the data source), it did so for so short of a time that it shouldn't really "count" when looking at long-term data. Secular bulls and bears are over many years, so a few days worth of data is really not going to make a difference. If you follow the link (S&P 500 P/E table), you can see that in 2009 there is no month that starts with a P/E lower than 10. Of course it may have happened in the middle of the month and gone back up before the end of the month, but a couple of days isn't going to really make a difference. So to say that the market was below 10, even "briefly" doesn't show that the market was in the "lows" of a bear market.

Another point of contention with this article is that if you want to look at "long-term" data, such as when looking at a secular bull or bear market, you should use data that compliments what you are looking at. In this case, if Tom wanted to look at P/E ratios as a sign of what the market is doing, then looking at a trailing 12-month P/E ratio won't give a true picture. Instead, he should have looked at a trailing ten-year P/E ratio, or the "Shiller P/E". The Shiller P/E ratio is based on the average inflation-adjusted earnings of the last ten years. Professor Robert Shiller discusses this his book "Irrational Exuberance". A look at the Shiller P/E (Shiller P/E table), during the years I mentioned above, (1947-1958) would show you that the P/E was above 15 (median is 15.87) in 1954. This would help an investor see what the long-term trend was doing. People were bidding up stocks faster than earnings were growing, which is basically what a bubble is. And while such a market can exist for some time, it eventually will end with a bust.

A look at today's Shiller P/E is not a pretty picture. It currently stands at 23.42. It fell for all of 6 months in the depths of the 2009 recession, but since then has soared back up to above 20. Other than those 6 months, it's basically been above its median since Jan 1991. This means that investors are willing to pay more for each dollar in earnings than is historically the case.

While I don't pretend to know where the market is heading, I always look at history to see where it's been. "Regression to the mean" holds true for stocks as well. Historically the S&P 500's trailing 12-month P/E has a median of 14.49, and the Shiller P/E is 15.87. Currently the trailing 12-month and the "Shiller" P/E are at 17.29 and 23.42 respectively. If this is the end of the secular bear then I hate to think of how overvalued the market must be, and how much more overvalued it will become. Instead, I think that we will continue to see some cyclical bulls within a secular bear market for some more time to come. This isn't a pessimistic view, rather this is a great time to try to find value and dollar-cost-average into investments, so that when the bulls do come you are ready.

(All data for the Shiller 10 yr. P/E ratio can be found on Prof. Shiller's website.)

Disclosure: I am long RSP. 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.