Secular Bear Market
Are We Still in One?
Van K. Tharp, Ph.D.
Since my book Safe Strategies... came out, I have been saying that we are in a secular bear market. Most of my beliefs about this
come from the wonderful work of Ed Easterling
(Unexpected Returns: Understanding Secular Stock Market Cycles) and Michael Alexander
(Stock Cycles: Why Stocks Won’t Beat Money Markets Over the Next Twenty
Years). Alexander’s book was published at the end of the secular bull market in 2000. Easterling’s web site had predicted a bear market starting in 2000, even though the book wasn’t published until 2005.
A lot of people try to define a secular market by the health of the
economy; however, this is inaccurate. There are periods in bear markets when the economy does quite well, and there are periods in a bull market when the economy can be doing poorly. The following table shows the bull and bear secular markets since 1900. Both types of markets had periods of economic expansions and contractions to various degrees within them.
Secular markets relate to the cycles of corporate valuations based on the price earnings (PE) ratio. During a
secular bull market, PE ratios go up. During a bear phase, the PE ratios go down. This has nothing to do with any underlying economic conditions, although bear phases do seem to correspond to inflationary or deflationary periods.
So what’s been happening to the PE ratio since 2000? Robert Schiller’s version (which is based upon a smoothing function) looks pretty much as expected. The PE has dropped dramatically since 2000. The following chart is from Schiller’s website:
You can see the end of the secular bull market and start of the secular bear market in 2000 quite clearly drawn with this data. PE ratios have had two small upswings since 2000, but the ratio is definitely on a downward spiral. Now look at the next chart, which shows the PE ratios based on real earnings. Can you believe it?
It shows a distinct 2000 peak and initial drop as in the Schiller chart, but then it shows something very abnormal happening now. Based on real earnings, the S&P 500 PE ratio is more than 3 times higher than its 2000 high. All I can say is “Wow!” Incidentally, I don’t look at this data (usually) more than once each year. A fund manager in our Blueprint class two weeks ago was kind enough to point out this occurrence to me.
Did we suddenly begin a secular bull market? Did the last secular bull never end? What is going on?
What’s going on is a statistical fluke. First, the PE ratio is based upon real earning, including one time write offs. The 2008-9 period saw a massive drop in S&P earnings. Look at the magnitude of the recent earnings drop.
Chart source: www.multpr.com.
The PE ratio has spiked up simply because earnings have fallen so much farther and so much faster than equity prices have fallen. That’s what is happening.
What Would You Do?
Now let’s go back to the very beginning of this year. Suppose you are the incoming administration (whether you are a Democrat or a Republican president is irrelevant), when corporate earnings were flagging and it was in your best interest to get the economy booming. The situation
is pretty dire because debt levels are way up and countries are losing trust in the dollar, but you have to do something. You could manipulate the statistics fed to the public such as the CPI, but that’s already been done as much as possible. So what do you do to stimulate things?
- Lower interest rates to nearly zero.
- Stimulate the ailing car industry by creating Cash for Clunkers—a program that loses its effect as soon as the program ends.
- Stimulate the housing industry by giving a rebate to first time homebuyers. (Such a program qualifies poor people for buying a declining asset and could cause the potential for many more mortgage defaults in the future. One of my houses in Memphis was purchased by a lady who had to borrow most of her deposit from her 401K. She also required that I pay most of her closing costs so that she could afford to buy the house from me. On a national level, doesn’t this sound like another housing disaster waiting to happen?)
- Use your banking friends—like Goldman Sachs—to manipulate the market.
(More on this below.)
Wouldn’t taking all of these steps get the economy booming? You would probably think so given where the Dow and S&P indexes are today. The following chart of the S&P 500 shows a 50% plus rise since early March.
How to Manipulate a Market
A fund manager from the USVI at the Peak 101 Workshop two weeks ago mentioned that trading for him is
especially difficult right now because so many formerly reliable market factors and relationships simply don’t work anymore. The current S&P PE ratio “imbalance” mentioned earlier is but one example. In large part, I believe these effects arise from the government pouring money into the stock market through big money players, especially Goldman Sachs.
In a July feature article in
Rolling Stone, Matt Taibbi suggested that Goldman Sachs has manipulated and profited handsomely from eight market bubbles since the Great Depression. These include the energy bubble of 2007-8 and the bailout bubble of 2008-9.
Reported elsewhere in July, a former programmer was accused of stealing some valuable software from Goldman Sachs. Interestingly, the Assistant U.S. Attorney on the case said, “The bank has raised the possibility that there is a danger that somebody who knew how to use this program could use it to
manipulate markets in unfair ways.” (emphasis mine).
Here, though, is the best part according to the assistant U.S. Attorney: The proprietary code lets the firm do “sophisticated, high-speed and high-volume trades on various stock and commodities markets,” prosecutors said in court papers. The trades generate “many millions of dollars” each year. (A Bloomberg article on the theft noted that in 2008 Goldman earned $2.3B.
In millions, that would be two thousand, three hundred millions.)
From a technical standpoint, notice what happened on that last price chart of the S&P
when the index hit its 200 day moving average (i.e., the thin red line) at the beginning of June. It tracked the MA down for about five weeks and then took off again. Also, notice that the entire index
price increase since early March has been on decreasing volume.
From a fundamental standpoint, companies are actually much weaker now than they have been in several quarters—earnings are atrocious compared with recent years.
Yet, the market has been going up strongly for over six months now. Why? Draw your own conclusions, but I hope you don’t truly think that the economic picture is anywhere near as rosy as the market’s current level might have you believe.
Van Tharp: Trading coach, and author, Dr. Van K. Tharp is
widely recognized for his best-selling books and his outstanding
Peak Performance Home Study program - a highly regarded classic
that is suitable for all levels of traders and investors. You can
learn more about Van Tharp at www.iitm.com.