Secular Bear Markets (red) since 1900. Source: Crestmont Research
I like this chart, but I would change one thing: the bear that started in 1929 could extend clear through to 1948 due to inflation and multiple compression.
Inflation (regular CPI) has reached double digits in the final years of each of the last secular bears. It was inflation that made the 1910s and 1970s markets into bears, since the nominal Dow was trending sideways.
Previous secular bear markets haven’t ended until PEs are compressed to near 10. Right now the S&P 500 trailing PE is near 15, with the Shiller PE over 23.
Hi Mike – Great point about previous secular bear markets ending with low P/E’s and high inflation. That makes me think of two questions. First, assuming the current secular bear ends in a similar fashion, do you think it is likely that that we will get to the P/E lows more through the numerator (eg, the S&P 500 falling hard) or more through the denominator (eg, inflation boosting corporate earnings)? Second, do you have any ideas on what could trigger significant inflation? For the last few years, my impression is that the natural state of the world has been deflation; central bankers’ extremely aggressive monetary policies have not generated much inflation but have sort of battled deflation to a draw. Will the central banks find a way to be even more aggressive if there is another stock market plunge and/or another major recession?
Hi Rob,
I think it is highly likely that the numerator shrinks by 35-50% over the next 2-3 years while credit markets contract again. At present we have a 4.5 year-old bull market that has reached an extreme in valuation, coinciding with investor complacency, rising Treasury rates, and a slowing economy.
Corporate profit margins are highly elevated and due to revert to the mean during any cyclical bear market. That said, we’re talking about the Shiller PE, so a drop in earnings for a couple of years won’t have a great effect on the denominator.
After such a washout with more debt writedowns and a restoration of value, the conditions may be set for credit expansion and an increase in monetary velocity. We have no reason to believe that central banks will be any less eager to print, but such printing doesn’t directly create inflation. That takes a change in risk appetite and cleaner balance sheets.
What makes a secular bull is profit growth plus multiple expansion as inflation and fear subside. Right now we are near the top of the profit growth channel, with a very high multiple on elevated profits. We’ll eventually experience the opposite, and I think I will be able to recognize it when I see it, but how and when we get there is foggy.