Tiho Brkan | Sep 02, 2012 05:17AM ET
Featured Article
Several days ago, I was in the middle of my usual morning reading, which led me to the chart below (thanks to Wells Capital Management). The article read: BEST EVER Post-War Stock Market Rally! and went on to explain how 800 plus days from the post-recession low, the current rally has gained 110%, beating all other famous generational bottoms from 1949, 1974 and 1982. With that in mind, I thought I would write about historical trends of the stock market for this week's feature section.
In the last century there have been three great secular bear markets. These are usually known as long sideways trading ranges, where the common theme tends to be frequent recessions, contracting valuations and general investor pessimism. While dates tend to vary slightly, the chart below shows secular bear periods to be from 1906 to 1920 (blue), from 1929 to 1949 (red) and from 1966 to 1982 (green). The current secular bear market started in year 2000 and is highlighted in black.
The previous three secular bear markets experienced 4 major sell offs in the range of 20% or more (1930/40s we had 5), while the current one has seen only two so far. While many "gurus" are very eager to call the end of the current secular bear market, a quick glance at the historical trends in the chart above, will rule that out very quickly. Quite to the contrary, we could assume that there should be several more years of sideways movement and range bound prices to go with at least one more major cyclical bear market of 30% plus in declines.
A drop of 30% from the current levels of about 1,400 would take us below 1,000 on the S&P 500 and quite frankly would not be the end of the world (even though retail investors would panic like it was). Since secular bear markets trade in a sideways range, the majority of the losses do not occur nominally, but through inflation (chart below). When adjusted for inflation, an average secular bear market tends to lose about 60% or roughly two thirds of its real value over the period of 17 years. Currently we are only down about 7% in nominal terms and 30% in inflation adjusted terms (according to the US CPI data).
By now, you have probably noticed that when we compare the current secular bear market in inflation adjusted terms (black) it is the most overvalued in both price and time, relative to others. Hence why we are currently going through the BEST EVER Post-War Stock Market Rally! So what prolonged the current rally and what comes next?
As a side note, do keep in mind the astronomical overvaluations we saw during the Tech Mania of the late 1990s, which could have prolonged this secular bear market, that commonly runs for about 17 years, towards a longer 20 year span like in the 1930s/40s. After all, over 27 years has passed since the CAPE 10 was anywhere near single digit readings.
So if now is the time to expect another bear market of cyclical nature (30% decline), the million dollar question is, when will it be time to buy? While I cannot tell each one of you what to do, I can express my own opinions on what I plan to do in the future:
For a wise long term investor, who was willing to bet a farm on it, periods when CAPE 10 reached single digits and stocks returned 0% over 17 years occurred in three periods overs the last 120 years. These were between 1918 and 1923, between 1946 and 1949 and finally between 1978 and 1984. Buying equities during any of those periods and holding for at least 17 years, made fortunes. A buying opportunity, similar to those mentioned above, is not here yet. The important thing to understand for long term investors is that US equities are still overvalued. Mr Bernanke and Mr Draghi need to let the free market work and let us see at least one more bear market, please.
Disclosure: I personally do not own any stocks right now and currently hold short positions in most economically sensitive cyclical sectors (refer to trading diary).
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