Many investors and members of the financial press are only now recognizing that stock prices have lost ground over the last 11-plus years, labeling this period as the “Lost Decade”. Our opinion, based on extensive studies of previous secular bear markets, strongly suggests that investors should anticipate another “Lost Decade.” As we explain in great detail in our recently published book, Investing in the Second Lost Decade, today could mark only the mid-point in this secular bear market. This report covers the historic characteristics of long-term secular bear markets and when to anticipate the end of the current secular bear market.
What is A Secular Trend?
First let us define what a secular or long-term trend is and why it is important for investors to be able to identify it. Our investment decision-making process is heavily influenced by the sequential rhythm of the business cycle, which for the last 150 years has alternated between expansions and contractions. A secular trend is formed when a series of business cycles are linked together establishing long periods of stock market out or under-performance. These patterns typically last up to 20 years. In order to successfully protect and grow wealth, investors need to correctly identify which long-term price trend prevails. That is because the secular trend determines whether investors act primarily to accumulate wealth (secular bull) or to preserve it (secular bear).
What is the Current Secular Trend?
The 18-year period from 1982 to 2000 embraced the most recent secular bull market. Stocks were grossly over-valued and investors were wildly optimistic with unrealistic expectations at the conclusion of this secular bull. Since 2000, we have embarked on a much different and far less investor-friendly journey, which represents only the first half of a secular bear market. The chart below shows U.S. stock prices adjusted for inflation back to 1900. It strongly suggests we are currently in the 4th secular decline since 1900. The prior three secular trends began in the years 1901, 1929, and 1966 respectively, and lasted on average nearly 20 years.
When Will the Current Secular Bear Market End?
With the benefit of over 150 years of financial history, it is possible to establish benchmarks that tell us when valuations have reached pessimistic extremes. The first benchmark to compare secular bear markets is duration. The chart and table below both show that the last three lasted on average 18 years and 7 months. The current trend has only lasted 11 years and 10 months, indicating greater potential if it is to even approach the average. As well as being measured in time, duration can also be looked at from the number of business cycles experienced. Prior secular bear markets averaged between 4 and 6 recessions. So far we have only experienced two. Allowing for a best-case scenario of 4 business contractions, this also suggests that we are halfway through the current cycle.
Valuation is the second benchmark to use for comparing secular bear markets. Arguably the most popular long-term measure of stock market valuation is the price investors are willing to pay for corporate earnings (Price to Earnings, or P/E Ratio). Why at one time are fearful investors only willing to pay $6.64 for $1 of earnings, (i.e. 1982 Secular Bottom) while at another time investors are eager to pay $44.20 for that same $1 of earnings (i.e. 2000 Secular Peak)? The answer lies in the extremes of confidence or lack thereof only seen at major secular turning points. Take a moment to study the Shiller P/E reading at key turning points as summarized in the Table above. Notice at the beginning of secular bear markets, the average P/E ratio is 27.3 (confidence high), in contrast to the average P/E ratios at the end of these periods that are 6.9 (confidence low). The current Shiller P/E reading is roughly 21. We may have traveled a long way from the 2000 historic overvaluation peak (P/E 44), but clearly there is a long way to go to reach truly undervalued levels once again.
Based on previous cycles, it is therefore not difficult to conclude that the current secular bear market has further to run in duration (we are only halfway there in terms of years and recessions) and valuation (P/E ratios must return to bargain levels). The combination of duration and inflation-adjusted price declines grind away and erode investor hope. This is why it is not difficult to rationalize any number of economic or geo-political problems, yet to be addressed, that will push us toward the secular bear market bottom.