Stock Market Secular Bottom Still Several Years Away
Erik McCurdy | Jul 05, 2012 02:09AM ET
We spend a great deal of time emphasizing the importance of maintaining a big picture perspective as both investors and traders. Without an understanding of the secular and cyclical environments within which the financial markets are operating, it is not possible to accurately measure the potential risk and reward of investment and trading positions.
The stock market has been in a secular bear market since 2000. Market behavior clearly signaled that a secular inflection point was approaching and our Secular Trend Score (STS), which analyzes a large basket of fundamental, internal, technical and sentiment data, issued a long-term sell signal in December 1999. Following the topping process in 2000, a prototypical secular bear market began that continues today.
One way to gauge the development of stock market secular trends is through the analysis of valuations. Secular bull markets begin at low valuations with compressed multiples and end at richly valued levels, after which secular bears slowly grind valuations lower into the next secular bottom. There are many methods that can be used to calculate market valuations and the following graph from Q Ratio and the relationship between the S&P 500 index and a regression trend line.
The graph clearly displays the secular swings from undervalued levels to overvalued levels during the last 110 years. Note the extremely overvalued levels achieved before the crash in 1929 and during the internet bubble in the late 1990s. According to these measures, the S&P 500 index is currently 35 percent to 49 percent above the long-term valuation trend line. Additionally, stocks typically move 40 percent to 60 percent below that trend line before forming the next secular bottom. Therefore, this analysis suggests that valuations will move substantially lower before the upcoming secular low develops several years from now, agreeing closely with the current state of our STS.
Following the generation of the last secular sell signal in 1999, the STS has remained in negative territory. The failure of the STS to return to positive territory during the last 12 years suggests that the current secular bear market remains in the middle stage of its development and forecasts several more years of poor investment performance heading into the next secular low. Secular inflection points form slowly, usually over the course of 6 to 12 months, so the STS will provide plenty of advance warning when the next true investment opportunity develops in the stock market.
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