Too often as investors we become wed to our individual investments or narratives, and refuse to acknowledge major trends taking shape before our very eyes. Often this results in refusing to sell investments that performed well in the past, while neglecting to take advantage of current or future investment opportunities. One way to avoid the trap of being stuck in yesterday’s investments is to look at history for context and, most importantly, how assets compare in value over time.
“Those who fail to study history are doomed to repeat it” – George Santayana
The stock market moves in long-term, i.e. "secular", cycles that are either bullish or bearish. Most secular bear markets have lasted between 10-15 years and the U.S. stock market entered a secular bear market in 2000 when the technology bubble burst 13 years ago. Given that we are well within the average timeframe for a new secular bull market to begin, in 2011 I highlighted a number of fundamental reasons why investors should begin preparing for such a shift in the market through a two-part series (see part 1 here and part 2 here).
In the first part I pointed out that most secular bear markets end with low valuations where we often see single-digit price-to-earnings (P/E) ratios. Some perma-bears pointed out that the S&P 500 didn’t reach a single-digit PE and suggested another massive bear market was ahead of us to compress valuations further. However, this objection is really splitting hairs as the S&P 500 hit a PE multiple of 10.56 on March 6th 2009, which was only 0.57 points away from a single-digit PE multiple and certainly well within range for a secular bear market low. Going further, it was noted:
While the Dow Jones Industrial Average (DOW) reached a PE ratio of 12.19 at the March 2009 low, 24 (80%) of the 30 DOW stocks reached single-digit PE territory. Moreover, 90% of the 30 DOW stocks saw their 21-year PE low occur over the last three years [see table below], which is something you only see near secular bear market lows. I find it disingenuous to argue one’s bear thesis of pointing to a lack of single-digit PE ratios for the major stock market indexes but fail to point out the abundance of individual stock single-digit PE ratios. Investors over the last three years were presented with valuations at 21-year lows for 90% of the DOW—quite the investment opportunity!
Valuations in 2009 did in fact correspond to levels associated with a major stock market bottom; and although many were skeptical that the market would exceed its prior highs, as it has now done, a key point that I have stressed continually in my articles is the importance of not obsessing over the major indexes, but to focus on the message also given by individual stocks:
Since all-time highs are not something characteristic of a secular bear market, it is quite telling that the present secular bear market is becoming long in the tooth given nearly a third of the DOW 30 stocks hit all-time highs this year [see table below]—a statistic conveniently lost on the perma-bear crowd. Just like the appearance of more and more green leaves on a tree signals the transition from winter to spring, so does the occurrence of individual stocks breaking out of their respective secular bear markets and hitting new all-time highs signal the macro secular bear market that began in 2000 is coming to an end and a new secular bull market is in the process of forming. It is this fact that I argue that investors should begin to switch from a secular BEAR market investing philosophy to a secular BULL market investing philosophy.
Having an understanding of historical cycles and paying attention to market signals can help investors to remain invested in the right asset classes and know when to get out. Knowing that, historically, secular bear markets last 10-15 years, investors more than a decade past the 2000 bubble peak should have been retooling their investment mindset and began looking for clues of a shift to a secular bull market. That shift was visible first in individual stocks hitting all-time new highs and then later in entire sectors hitting new all-time highs.
Let's now turn our attention away from just the stock market, however, and look at major shifts taking place with other asset classes: commodities and bonds.
Every Beginning Is Some Other Beginning's End
Oftentimes when one asset class is moving from a secular bull to bear, or vice versa, so is another asset class in response. With that said, let's examine the historical cycles of bonds and commodities. In part two of the series mentioned above, I highlighted the work of Barry Bannister:
Perhaps the most influential strategist that has shaped my macro and secular views is Barry Bannister, Managing Director at Stifel Nicolaus. Mr. Bannister nailed the macro call of hard assets (commodities) versus paper assets (stocks, bonds) in an 87-page report back in 2002 when he worked for Legg Mason. He made the call for an inflation cycle occurring from 2002-2015 amid strong growth from China (see image below):
Source: Barry Bannister, 1Q11 Macro-Trends: Early Reflation Feels Like Growth
Given we are in the later stages of his secular time window, Mr. Bannister now favors U.S. growth stocks over commodities from a long-term investment perspective. When looking at long-term returns (10-year compounded growth rates) of commodities versus stocks we can see that commodity inflation is near the upper end of its range seen over the last 200 years while stock returns rest near the bottom of the last 150 year range (see image below). For this reason value investors such as Jeremy Grantham of GMO and Mr. Bannister are warming up to large-cap blue-chip growth companies over commodities.
Source: Barry Bannister, 1Q11 Macro-Trends: Early Reflation Feels Like Growth
Continuing this theme of looking at one asset class to another, in 2012 I penned an article titled, “Can You Tell the Difference between Gold and the S&P 500?” with an excerpt below:
When is the best time to be bullish? When everyone is bearish! Often major inflection points occur when you have capitulation, whether that is bullish or bearish capitulation. These inflection points are always visible in hindsight and investors tell themselves they should have seen it coming. To help grasp that a major inflection point has occurred it is often helpful to study historical inflections points and compare them to the present situation. When doing so it should become clear that we witnessed another major inflection point in the stock market.Rorschach Test
Below is an image of gold and the S&P 500, can you tell which is which?
I bring up the above chart because it shows one major inflection point in hindsight which no one would disagree with. Overlaid is a second set of data and the similarity between the two series cannot be overlooked and the simple Rorschach test above may perhaps open up investor perceptions if one allows for some intellectual freedom.
Before revealing which is which in the image above, I wanted to highlight the importance of sentiment near major turning points. The article I wrote above had two very important charts that highlighted how wrong the investment climate was near major turning points. Just look below at the Business Week magazine cover just before the great secular bull market in stocks in the 1980s and 1990s, and the second image which highlights popular books that came out just before the stock market entered a new secular bear market.
Source: Bloomberg
Source: Bloomberg
Now if you think of the sentiment back in 2000, all the rage was technology stocks while no one considered commodities or precious metals as an attractive investment. Fast forward to today, gold is no longer as cheap as it was in 2001 nor is the stock market as expensive as it was in 2000, as stocks over the last decade continue to make record sales, record earnings, and record cash flows to compress valuations from their 2000 highs. Later in the article I revealed the answer behind the Rorschach test chart with commentary and the chart provided below:
Below is the price of gold just a few years after its 1980 peak to its early 1999-2001 low, with the price-to-sales (P/S) ratio for the S&P 500 from 1996-2012 shifted back. Twelve years of rising company sales has compressed the P/S ratio for the S&P 500 to such a level that it is more than likely we witnessed the price and valuation low for the secular bear market in stocks that began in 2000, with 2009 representing the turning point for the stock market just as 2001 marked the turning point for gold.
Source: Bloomberg
Investing is often not so much about choosing the best opportunity, but identifying major trends and minimizing losses. One way to do this, of course, is by looking at value. For example, between three investment classes—stocks, bonds, and gold—one can easily glean which asset class represents the best value. In terms of gold, we see that in the late 1990s to early 2000s, stocks (top panel), housing (2nd panel), and bonds (4th panel) were at or near multi-decade extremes relative to the price of gold. Fast forward thirteen years and we see that much of the past relative-value in other asset classes has been evaporated as gold has outperformed. However, looking at relative valuations clearly shows that gold no longer possesses the cheap relative valuation qualities it did at the turn of the century. As such, investor’s bullishness and affinity towards gold should not be as strong now as it was when gold was much cheaper on a relative basis.
Source: Bloomberg
Near the start of the year I declared that “The Secular Bear Market in Stocks Is Over” and made the case that we would see new all-time highs in the major stock indexes. Furthering on the concept of relative valuation, in that article I took a look at stocks versus bonds and showed that we had hit a major extreme in terms of relative returns of bonds over stocks not seen since the Great Depression. An excerpt from the article is provided below:
The outperformance of stocks over bonds is likely to continue for more than a decade as we hit a major extreme in long-term relative performance at the March 2009 lows. At the time the 10-year relative return spread between the S&P 500 Total Return Index and the Barclays Long Term Treasury Bond Total Return Fund reached levels not seen since the Great Depression. This is highlighted below in the bottom panel with the blue circles highlighting major secular turning points in asset class performance between stocks and bonds. As seen below, we have seen three occasions when stocks underperform bonds over a 10-yr horizon to a significant degree and after reaching these levels the stock market has embarked on long secular bull markets as occurred after World War II in the 1940s or the great secular bull market that ran from 1982-2000. Given how low interest rates are, it’s not hard to imagine that bond returns may be seriously found wanting relative to stock returns in the decade to come.
Source: Bloomberg
Another way of looking at secular cycles is the 10-year smoothed average of the S&P 500’s annual returns. At the March 2009 low we reached an oversold condition not seen since the early 1920s, which was followed by the “Roaring 20s” that preceded the Great Depression. Moves near or into negative territory have also marked major bottoms in the stock market over the last century, providing more support that the March 2009 low marked the secular bottom in stocks.
Source: Bloomberg
Looking at just secular cycles in the stock market shows a certain historical rhythm. When taking a 10-year moving average for the S&P 500’s year-over-year returns, we see that there were 36 years separating the early 1940's low from the middle 1970's low. There were 34 years that separated the 2009 low from the middle 1970's, which supports the notion that March 2009 was likely THE secular bear market low in stocks. The shortest period between secular bull market peaks was 23 years while the longest was 41 with the average of the last three lasting 31 years. Given those time frames and starting from the last secular bear market peak in 2000, the secular bull market may run until 2031...
Source: Bloomberg
Summary:
I must admit this article is far longer than I had anticipated, but I’ve talked with too many people stuck in yesterday’s investments (commodities) that are so far deep in their investment bunkers and taking major losses that I felt it necessary to recap some of these major long-term investment themes. Commodities are no longer as cheap as they were in 2000, and bonds are certainly not as cheap as they were in 1980 when we had double-digit interest rates. While stocks have come a long way off their valuation lows in 2000, a look at historical secular bull markets and comparing historical relative valuations with bonds and commodities suggests that over time, stocks are likely to prove to be the better investment, which is what legendary value investor Warren Buffett, the “Oracle of Omaha”, has said himself. If you don't think I'm right, maybe you're willing to listen to him?
Warren Buffett: Stocks Not in a Bubble; Best Place to Be for the Next 20 Years
