PORTFOLIO POINT: Global economic conditions, combined with past trends, indicate we could be on the cusp of a secular bull market.
Is a bull market under way, or just around the corner? The signs are already here that markets around the world are beginning to turn.
But it’s early days, and which way markets will trend is anyone’s guess in reality. A look at past secular bull and bear markets may hold some of the keys.
Secular market trends
Secular refers to a long-term market trend as against a primary one that lasts just a few years. The first chart shows America’s Dow Jones share price index since 1900. The Dow comprises America’s 30 largest listed companies. Note how secular bear markets (including the extraordinary crash of 1929-32) occupied just over half the last 112 years. These charts show only accumulated capital gains/losses, not dividends.
The second chart shows America’s S&P 500 index (which covers its top 500 listed companies) stripped of consumer price inflation to show what the American market was worth in constant dollars. Note how sideways movements that look benign in the above chart actually represented serious losses of value for periods as long as 20 years.
This is a compelling reason to be a successful market timer, because no one starting retirement wants to be caught in an extended bear trap. Since 1990 Japanese shareholders have seen the Nikkei share index slide 76% with no sign yet that it’s on the mend. Only those trend-trading Japan’s frequent big market rallies have made good money.
I don’t know whether 2013 will usher in a new secular bull market or just be a continuation of the global secular bear market that started in 2000. What I do know is that our timing signals will get you into shares (through an exchange-traded fund like the SPDR S&P/ASX 200 Fund) early in any rally, and out early in any crash.
Over my next two articles I want to rehearse both sides of the argument for where the sharemarket is heading in future. Today I present the case for the bulls. Next time I will do the same for the bears. I will finish this series with a discussion of how to invest, whether the market outlook is bright or bleak.
Shares are still the best asset class
Notwithstanding the market’s ups and downs, shares still offer better total returns (capital gains plus dividends) than property, bonds or cash over the long term. The trick is to avoid market crashes so that you you’re not scared to reinvest in the sharemarket after it has bottomed.
Bull markets start when few investors own the market
Brad McFadden, writing in the latest issue of YourTradingEdge magazine, says we are at the foothills of the next secular bull market because the existing secular bear market is spent:
“Spotting the first signs of a bull market can be far simpler than predicting a downturn, given that we are programmed to avoid losses and take profits...
“Bull markets start when few investors own the market, and most people find comfort on the sidelines. Metaphorically speaking, a kind of Stockholm syndrome sets in to market sentiment, turning investors from profit-seekers to victims of their perceived oppressor – in this case, their memory of the GFC.
“However, analysis of market fundamentals away from the day-to-day noise of excessive opinion will reveal strong signs of an early-stage bull market.
“Significant downside in markets occurs only when a large pool of marginal sellers panic and dump stocks en masse, sending stock prices tumbling. I refer to these markets as ‘lots of weak hands’.
“There are about 20% fewer shares in existence now than just five years ago. Large issuers of shares have bought back stocks over the past three years, leaving equity markets the most ‘under owned’ they have been in at least 30 years.
“Equities are now in the hands of a relative few, who stand to gain significantly when investors start creeping off the sidelines and out of the ‘safety’ of treasuries.”
A recent analysis by UBS found that between 1991 and 2012 Australia’s top 200 stocks started their rally about 60% of the way through a profit downgrade cycle lasting on average 9.4 months, but ranging from one month to 53 months. In other words, share recoveries don’t wait for the first profit upgrade after a downgrade cycle, but begin well in advance of that point. Earnings downgrades have persisted for the past three years, which might suggest that the cycle is already 60% completed.
The Dow Jones index expressed in gold has lost 83% of its value.
Reinforcing this bullish outlook is the next chart, which shows America’s Dow Jones share index expressed in gold. Many consider gold to be the only genuine “currency” since it can’t be printed. On this basis, the Dow has lost 83% of its value since 1999. This rivals the Dow’s crash in gold terms between 1929 and 1932, the worst years of the Great Depression.
Bulls contend that a fall of this magnitude suggests the stockmarket is very close to bottoming, if it hasn’t done so already. Hence those who are timing the market stand to reap the rewards of catching the next boom early, whereas investors who have fled the market might be too afraid to get back until late in the cycle.
On the other hand, if the market has further to fall, market timers will stand aside whenever it heads south and return whenever it points north. As Japan has shown, trend-trading can make money in a secular bear market simply by riding upturns and avoiding downturns, even when the long-term direction is down. But hopefully the optimists are right and the market is on the cusp of a new journey heading up.
Share yield is now well above bond yield
Another bullish argument is that the dividend yield on shares has risen above the interest yield on bonds. This is illustrated by the following charts for Australia, but the same holds true for America. The last time the yield gap favoured shares was in the 1950s, which proved a golden age for equities. When investors can’t earn enough from bonds they seek out shares.
Prior to 1957, American dividend yields exceeded bond yields. We have now returned to an era that favours shares over bonds.
Price earnings ratio at a two decade low
Optimists argue that with the exception of the 2008 market crash, both the trailing and forward price earnings ratios for Australia is at a two decade low, suggesting that shares are cheap. It’s at such times investors using fundamental analysis gravitate back to equities.
Households have no further reason to deleverage
Bulls say that debt deleveraging will soon end because household debt service payments as a proportion of personal disposable income are back to where they were in the early 1990s, which marked the start of a credit binge that fuelled economic growth and the sharemarkets. America is where the global financial crisis started, and the bulls argue that is where it will end.
Deleveraging has a limited lifespan
Not every country has reacted to a financial crisis like Japan. Sweden and Finland illustrate this. After their banking systems collapsed in 1990, they suffered one to two years of recession, then four to six years of private-sector deleveraging before markets rebounded allowing the public sector to start repaying its debt. If the developed world follows this scenario, then the secular bear market should end between 2012 and 2015.
Morgan Stanley’s European Strategy desk in 2009 studied 19 secular bear markets, all but one of which was post Second World War. It concluded that the typical secular bear market witnessed a fall in the share price index of 56% over 29 months, then a rally of 70% over 17 months, after which it oscillated within a band width of 52% for another 5.6 years. On its definition the average secular bear market lasts only 9.4 years, which would suggest that the one that started in January 2000 ended on schedule with the trough of March 2009. If that is correct, then the general uptrend since then marks the start of a new secular bull market.
US housing market on mend
The global financial crisis was triggered by a collapse of the US housing market. The average American home fell by 36% in value. Housing starts have bottomed and are picking up. That would suggest the worst of the GFC is over and from here on economic recovery should accelerate. The biggest risk now is a bond bust as investors flee low-yielding income securities for higher-yielding shares.
Central banks committed to cheap credit
A low debt servicing cost to disposable income will only hold if interest rates stay low. Bulls argue the central banks of America, Europe, UK, Japan and China have been flooding the world with money, which will keep interest rates down for the foreseeable future. Indeed the US Federal Reserve has promised to hold short-term interest rates near zero until at least mid-2015. Cash reserves are piling up in bank and corporations. Once US banks relax their excessively tight mortgage lending standards, consumers will borrow for housing and other purposes again.
The world economy is rebounding
The world’s GDP collapsed in 2008. Since then it’s been positive and the world’s leading index of economic activity does not suggest a recession around the corner. Less developed countries don’t have the debt problems of developed countries. About 45% of the earnings of S&P 500 companies are now generated in emerging economies enjoying strong growth. We should stop thinking of national stock exchanges as only reflecting national production.
Australia’s economic performance has been better than that of other Organisation for Economic Co-operation and Development (OECD) countries. Indeed, Australia is unique in that its GDP per capita is now higher than before the global financial crisis. Australian investors should stop cringing and start investing on this argument.
Next time I will put the case for the bears.
I will end the series by asking the obvious question: How to invest in the future, whether it’s bullish or bearish?