It looks like a duck, quacks like a duck, but it’s a secular bear
John Authers
The S&P 500 is at an all-time high. If this is not a bull market, what is?
Are we in a bull market, or are we still in a secular bear market? It is a profound question, and — at least when it is applied to stocks in the US — it also sounds like a stupid one. US stocks have more than trebled since March 2009. The S&P 500 is at an all-time high, and it has been rising, with only one interruption of any significance, for almost six years. The US labour market has now expanded for a record 50 months in succession, and the latest numbers outstripped the most optimistic projections. If this is not a bull market, what is?
Last week, an alert reader pointed out in a comment on ft.com that I am on record as saying that this is merely a cyclical rally within a bear market. After the last two years, that call has gone from looking sober and responsible, through a period of appearing eccentric to, now, looking downright wrong. So I must revisit it. What does it mean to say that we are in a secular bear market, and could the US really still be in one?
First, the chart shows that the market’s performance is not quite as great as it appears. Since it peaked during the 2000 tech bubble, the S&P 500 has badly lagged behind long-dated bonds and gold. It is still lower in real terms (after inflation) than it was in 2000 — although with reinvested dividends, its investors would have beaten inflation by 31 per cent.
Next, let us make what many will call a hair-splitting distinction. There can be cyclical bull markets within a secular bear. Secular markets are driven by long-term shifts in the valuation put on stocks, and they last for decades. Ed Easterling, of Crestmont Research, who has popularised the concept of secular market cycles, suggests that cyclical rallies differ in that they cannot be trusted. During bear markets, investors must think tactically, and join in with rallies when, for example, the Federal Reserve uses monetary policy that boosts stocks, whilst remaining wary.
Secular bears and bulls are marked out by peaks and troughs in the price/earnings ratio. To cut out the noise of shifts in the economic cycle, the p/e is cyclically adjusted, and compares share prices to average earnings over 10 years.
As calculated by Yale University’s Robert Shiller, this measure hit historic lows, in single figures, in 1921, 1932 and 1981. Each time signalled a great time to buy. In early 2000, it hit an all-time high of 44, it bottomed in 2009 when it never quite got below 10, and it now stands at 26.5, as high as it has ever been outside the historic bubbles of 1929 and 2000. Ergo, the tripling since 2009 is still no more than a bear market rally.
If this sounds silly, think of the rally that started with the invasion of Iraq in 2003 and ended with the credit crisis in late 2007. US stocks doubled to reach a new high. But we can plainly see that this was just a bear market rally.
The current rally, though, has lasted longer, taking the S&P more than 100 percentage points further. It started amid the despair of early 2009, when some measures of investor optimism hit an all-time low.
To quote Liz Anne Sonders, chief US equity strategist at Charles Schwab, if it looks like a duck and quacks like a duck, it’s probably a duck — and this looks like a secular bull market. She suggests we are probably only in its “middle innings”.
If this is really nothing more than a cyclical bull market, then the p/e on the market must fall below 10 before the next secular bull market can start. This happens either through an increase in earnings (of 160 per cent or so) or a fall in price (of more than 60 per cent), or more likely a drawn-out combination of the two. That, I admit, sounds outlandish.
And yet, and yet, and yet. Valuations are stretched, and profit margins are historically high. Earnings owe everything to the low rates that have pumped this rally all along. Earnings before interest, tax, depreciation, amortisation and depreciation remain below their 2007 peak. Since 2009, unprecedented monetary policy has given US investors little choice but to buy stocks.
Yes I can believe that we face a few years when the stock market grinds down until it is historically cheap.
What would make me abandon that idea? Earnings quality has picked up recently, with non-energy companies’ revenues growing at a 5 per cent clip. If that accelerates, while the stock market swallows rising rates without significant falls, it would be time to admit that I was wrong, and that March 2009 was a secular turning point.
That test is imminent. Meanwhile, it still makes sense to treat this rally with extreme caution.
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