History shows that US equity prices have consistently alternated between secular bull and bear trends. These price movements typically average 15-20 years in length and embrace several different business cycles. In April 2003 we published an article posing the question, “Whither the Secular Trend of Equities?” which laid out the case for the year 2000 being a secular or very long-term peak for the US stock market. Since the three previous secular bears averaged just over 18-years, our working hypothesis was for a weak market until sometime around 2018. Our view of continued secular vulnerability remains unchanged despite recent market strength.
Many point to record high equity prices in 2014 as evidence the secular bear ended in 2009 and the dominant trend is now a bullish one. That argument can be countered by the fact that record highs are nothing new in a secular bear market environment. For example, in 1909, seven years after the 1902 secular “peak”, prices were 16% higher (see point A in Chart 1). We see a similar situation between the 1960’s and 70’s, where the 1972 peak was 27% higher than that achieved 6-years prior (see point B in Chart 1) . The current differential between the November 2014 (so far) peak and that of August 2000 has been 36%. How, then, can we justify the label “secular bear” when nominal prices look otherwise?
Chart 1 – Nominal versus Inflation Adjusted US Stock Prices
The answer lies in the fact that over very long periods, equity prices (adjusted for inflation) offer a far more realistic way of looking at things. After all, if my stock doubles in price over, say a 10-year a period, and this is replicated by the overall price level, am I any further ahead, in our book, Investing in the Second Lost Decade (McGraw-Hill, 2012) we pointed out that over short periods of time, inflation is not a big deal, but over longer intervals it becomes critical as inflation cunningly eats away at the real purchasing value of your portfolio. A comparison of the secular trading ranges in the nominally priced upper panel of Chart 1 with the bear trends of the inflation adjusted series in the lower panel demonstrates that difference pretty clearly. The chart also tells us that in late 2014 the adjusted price series had reached a critical juncture point, just fractionally below the 2000 high. The dashed brown lines and solid arrows show that previous secular peaks became important pivotal points in subsequent periods. Bottom line; now is as good a time as any for anticipating a primary trend peak. Also, comparing the nominal and inflation adjusted MSCI AWCI Index with an adjustment using the G7 CPO shows performance is even less robust than that of the US. Therefore, it is difficult not to conclude that the secular bear is both a US and global phenomenon.
The Causes of Secular Equity Bear Markets
1. Structural Problems
“We’re seeing true currency wars and everybody is doing it, and I have no idea where this is going to end. The global elastic has been stretched even further than it was in 2008 on the eve of the Great Recession. The excesses have reached almost every corner of the globe, and combined public/private debt is 20% of GDP higher today. We are holding a tiger by the tail.” William White (Chairman of the OECD’s Review Committee Daily Telegraph 1/21/2015
Secular bear markets do not develop in isolation but are the product of structural problems in the economy and financial system. In turn, these fundamental and monetary trends are reinforced by long-term swings in investor sentiment. Structural problems are most commonly caused by excessive capacity in key industries, either through overbuilding (housing 2006), new competition (steel between 1975 and 1990) or obsolescence because of technological advances (newspapers today, not a key industry, but a good example). In addition an aging population in developed countries offers another headwind as it means fewer spenders and producers. A final characteristic is a top-heavy debt structure, which adds the additional burden of higher servicing costs.
In the current cycle dating from 2000, earlier excesses associated with the dot.com bubble and housing have largely been worked off. However, demographic problems continue to act as a headwind, as does the 300% plus total debt/ GDP ratio. Even so, this pales in comparison to Japan’s 650% .
One way we can graphically symbolize one aspect of these long-term economic trends is to calculate the ratio between nonfarm payrolls (predominantly full-time employees) and those who work part-time for economic reasons.
Chart 2 – Secular Equity Trends and the Labor Market
This relationship is not only a great leading indicator for business cycle work, but its long-term trajectories also reflect secular trends in equities. When the ratio is rising, it indicates that full-time jobs are being created at a faster pace than part-time positions. This is a favorable factor because full-time jobs generally pay more and provide superior benefits. Also, an expansion in full-time as opposed to part-time workers demonstrates a stronger commitment by employers because full-time personnel are more difficult and expensive to fire. Returning to Chart 2, the shaded areas indicate secular bear trends in US equities. Such periods also correspond with a series of declining peaks and troughs in the labor market relationship in the lower window. This series typically peaks ahead of recessions, which have been flagged by the red highlights. At the start of 2015, there were no signs of business cycle weakness, but the indicator is still in a secular decline.
2. Giant Swings in Psychology
Most observers believe it is earnings that drive stock prices, but Charts 3 and 4 show that it is investor’s attitude to those earnings, rather than the earnings themselves, that is important. Consequently, an understanding of the secular trend is an appreciation of the fact that investors are continually undergoing long-term psychological mood changes, similar to the swing of a pendulum in a clock.
Chart 3 – Inflation Adjusted Stocks versus Real Earnings (Smoothed)
Chart 3 tracks a 10-year moving average of inflation adjusted profits compared to an inflation adjusted stock market series. Note how profits actually rise during the three secular bear markets.