Are We in a New Secular Bull Market?

I just read the February letter from Tony Boeckh, author of The Great Reflation, and one of our highly regarded independent analysts. The title of his letter, “Are Equities Too Expensive for a New Secular Bull Market?” is provocative for those who believe we are still mired in a secular bear market. Secular bears look at long-term valuation measures and conclude that the stock market is too expensive for a long-term, multiple year bull market to occur. In our work, we look at several valuation measures, but the most conservative in terms of earnings is to use Robert Shiller’s methodology of normalizing, or averaging, trailing earnings over the past ten years. Averaging the earnings over 10 years smoothes the earnings number so that it isn’t distorted by cyclical peaks and troughs as the economy moves through the business cycle. The current 10-year average earnings are about $55 so the market’s P/E ratio at current prices (1321 S&P 500 close on 2/22/11) is 24x. History tells us there has never been a secular bull market beginning from such a high P/E ratio.

Boeckh, however, offers some other methods of looking at long term market valuations. He suggests using a long-term earnings trend line to estimate normalize P/E’s instead of using the 10-year average. Using the logarithmic trend of 60-years of earnings gets us to $66 of earnings, which means that the current market P/E is 20x. The long run average P/E is 17, so the market is expensive, but not frighteningly so. He then further adjusts earnings to show earnings yields (the reciprocal of the P/E ratio) versus BAA bond yields. Corporate earnings look very attractive in today’s very low interest rate environment. Finally he adjusts the P/E ratio for the amount of cash on today’s corporate balance sheets. Value investors would normally make an adjustment in the price component of the ratio since cash is considered to be easily returned to investors. The net result of his analysis is that the 2009 market lows will turn out to be THE market lows and that we are in the early stages of a new secular bull market.

What does that mean to us? Well…very little, actually. Our own valuation work shows the market to be fairly valued. While it is interesting to consider secular market cycles, our work is focused on identifying shorter market cycles within the secular trend. There are many cyclical bull and bear markets within a secular bear. This cycle is no different, with a bear market from 2000 – 2002, a bull market from 2002 – 2007, a bear market from 2007 – 2009, and now a bull market from March of 2009 to present. Most assuredly, this bull market will be followed by a new bear market. The question is when? Boeckh doesn’t believe this new secular bull will give investors the same high returns that secular bull markets have delivered to investors in the past. If this is the beginning of the next secular bull, then I couldn’t agree more. In my mind, actively managing portfolio risk will be a priority for years to come.

Lies, Damn Lies, and Statistics

Today the major guru of a research firm that we routinely follow was making the point that the momentum of the market is important, but the quality of the momentum is also important. He then went on to look at several underlying data points to make the case that it was prudent to be cautious about the current cyclical bull market. One of the data points he shared was to compare the percentage gain and the length in days of the current bull market to past cyclical bull markets that occurred during secular bears. For those who are wondering, secular market cycles are very long-term market moves and cyclical moves are the shorter-term bull and bear markets that occur within the secular time frame. Most cyclical bull and bear markets are measured in terms of years rather than months. During the current secular bear market, which began in March of 2000, there have been four cyclical market moves. The first was March of 2000 to either October of 2002 or March of 2003 (depending on your preferences for measuring this kind of thing). The second was the bull market that lasted from the 2002-2003 market troughs and lasted through October of 2007. The third was the cyclical bear from October of 2007 to March of 2009. And the fourth is the current bull market that began in March of 2009 and has lasted to the current date.

If you look at the list of S&P 500 Index cyclical bull markets that occur within secular bears going back to the 1930s, you find that there are 16 different cyclical bull markets during secular bear markets. The percentage gain for these bull markets ranged from 21.2% to 123.3% and the number of days from bottom to top ranged from 61 to 1,826 (the latter was the cyclical bull from 10/09/2002 – 10/09/2007). Our guru points out that the percentage gain for the current bull market is 79.2%, which is greater than the mean and median percentage gains from prior periods, which were 62.3% and 51.2%, respectively. Similarly, the 413 days of the current bull is lower than the mean and higher than the median durations of prior cyclical bulls in secular bears, which were 465 days and 337 days, respectively. Today’s message was that the current bull market has gained more than the average cyclical bull (79% versus 62% mean or 51% median) and lasted longer than the median but less than the mean (413 days versus 465 mean and 337 median). In short, this bull has gained enough and lasted long enough to be cautious.

However, just a few weeks ago another analyst at the same company used similar data to reach the opposite conclusion. Using data for the Dow Jones Industrials (as opposed to the S&P 500 Index), he found that the statistics show that the DJIA’s gain of 71% ranks only 8 among the 16 cyclical bulls that have taken place within secular bears. The longevity ranks ninth. In short, just looking at the rankings as opposed to comparing to the means and medians of previous data leads to a completely different conclusion about the percentage gain and duration of the current cyclical bull. The rankings suggest that this bull market has a long way to go in comparison with bull markets within secular bears in the past. It’s another good reminder to think carefully about the data as it is presented to be certain that you understand the “spin” in the message.