I think it’s safe to say that most people would look at the stock market since early 2003 and conclude that it is a bull market. After all, a popular definition of a bull market is one where a major stock index gains at least 20%. And since the S&P 500 index rallied well over 50% from its 2002 low, it would certainly more than qualify as a bull market by that definition. However, I think making investment decisions based on that definition of a bull market can result in disappointing investment returns.
For example, during the secular bear market of the early 1930’s, five of the six bear market rallies gained more than 20%. In fact, from a low of 199 in November of 1929, the Dow rallied 48% to a high of 294 in April of 1930 only to be followed by a decline of 86% before reaching an ultimate bottom of 41 in 1932. Defining those rallies as bull markets would have caused long-term investors some serious financial set backs.
So those rallies were obviously not the beginning of secular bull markets and I don’t think today’s stock market is a secular bull market either. In fact, you can include me in the circle of the minority of market observers — a minority that seems to include some of the most experienced investors — who believe that the rally that has taken place since 2003 is nothing more than a very strong and long bear market rally that will result in the resumption of the secular bear trend.
I think the secular bull market — the most powerful bull market in history — that began in 1982 ended in early 2000. It also signaled the beginning of a secular bear market that hasn’t didn’t come close to ending when stock prices bottomed in 2002. And you need to look no further than price/earnings ratios for proof.
| Starting P/E* | Ending P/E* | Cumulative Return** | |
|---|---|---|---|
| 1901-1920: BEAR | 23 | 5 | 1.4% |
| 1921-1928: BULL | 5 | 22 | 316.7% |
| 1929-1932: BEAR | 28 | 8 | -80.0% |
| 1933-1936: BULL | 11 | 19 | 200.0% |
| 1937-1941: BEAR | 19 | 12 | -38.3% |
| 1942-1965: BULL | 9 | 23 | 773.0% |
| 1966-1981: BEAR | 21 | 9 | -9.7% |
| 1982-1999: BULL | 7 | 42 | 1213.9% |
*The P/E ratio is based on the S&P 500 as developed and presented by Robert Shiller in Irrational Exuberance.
** The returns reflect the Dow Jones Industrial Average at year-end.
Source: Crestmont Research
There are two things you should learn from the data. The first is that since 1900, investing in the stock market during periods of high price/earnings ratios has resulted in inferior investment returns. The other thing is that, without exception, new secular bull markets don’t begin until p/e ratios get to single digits.
And there’s a logical reason for that kind of market behavior. Bull markets tend to go a lot higher and last a lot longer than anyone expects. Conversely, bear markets tend to go a lot lower and last a lot longer than anyone expects.
This phenomenon occurs because the final stages of secular bull markets are always fueled by excessive speculation, whereas the final stages of bear markets result in investors deciding that they can’t stand any more pain, the market is never going to come back again, so they just want out at any price. And when that occurs the news will be terrible and stocks will be dirt cheap. And yet nobody will want to touch them. That’s how bear markets end.
So where are we now? Not even close to a market bottom. In fact, we’re much closer to a historical market top than to any kind of bottom. Right now the p/e ratio for the S&P 500 index is about 18, still relatively high. So the current bear market has a long, long way to go before a new secular bull market can begin.
The market can get to low p/e ratios in one of two ways. Either the S&P gets so low that the p/e ratio for the index drops below 10. That happened during the bear markets of 1929-1932 and 1937-1941. Or the S&P could go through a very long period of sideways action while earnings catch up to price. That happened during the bear markets of 1921-1920 and 1966-1981.
I went through the last half of the one from 1966-1981 and I can tell you that even though the market ended that period about where it began, there were very powerful up and down moves during those years. However, the end result was that it was not a good time for long-term stock market investments.
Finally, I think that the current stock market is on the verge of a steep decline. All of the reasons for that are beyond the scope of this article but I’ll give you one that I consider quite telling. According to the Commitments of Traders report (COT), the net short position of commercial traders for the S&P futures contract is one of the largest in COT history. Ever since the secular bear market began, such a bearish position on the part of the “smart money” has signaled a steep market sell off within the next few months.
We shall see what transpires.
Larry Holmes
