Sam Ro at Business Insider recently posted “The Most Bullish Chart Your See Has A Big Stock Market Crash In The Middle Of It” in which he makes a very interesting statement:
“More and more Wall Street strategists argue we should think about stocks as being in the middle phase of a long-term, multiyear, secular bull market.”
He is correct. Over the past couple of years there has been a rising chorus of individuals warming to the idea of a new secular bull market. This is not surprising given the seemingly unstoppable rise of asset prices since the financial crisis despite a litany of geopolitical and economic headwinds.
Sam quoted Liz Ann Sonders who stated:
“Our view, which we have held since the market bottomed in 2009, is that the current bull market is secular, not cyclical. Secular bull markets — like from 1949 to 1968 and 1982 to 2000 — are extended bull markets characterized by above-average annualized returns and generally less-dramatic downside risk.”
That is the most important statement in the entire piece as it defines both the time frame and the context around which a secular market period exists. From this discussion we can do some comparative analysis to determine if the “ingredients” the spurred the previous two secular bull market periods exist today.
Then And Now
The following series of charts compare the two previous secular bull markets with the current market today. I have only provided commentary as necessary.
As I discussed yesterday, valuations are currently pushing more than 27x earnings on a trailing basis using Dr. Shiller’s cyclically adjusted methodology. At the beginning of each previous secular bull market valuations were in the single digits. I have notated when valuations have exceeded 25x trailing earnings which historically marked the peaks of bull markets rather than the beginning.
Here is another view of valuations and secular market periods for a better perspective of future expected returns. The yellow triangles note valuations where secular bull markets previously began. Importantly, note the market’s behavior at the start of periods where valuations were 25x earnings are higher.
One of the key arguments behind the push in the markets over the last six years has been the artificially suppressed level of interest rates that are currently nearing their lowest levels since WWII. As shown in the short below, interest rates rose during the secular bull market of the 40’s and 50’s as economic growth was strong enough, and steadily rising, to offset the drag of higher borrowing costs. Conversely, it was the fall of interest rates during the 80-90’s that drove the secular bull market as financial deregulation spurred massive household credit expansion.
Inflation, Wages, Consumption & Debt
The following chart is the real key behind the secular periods of the financial market historically. During the post-WWII expansion, as the U.S. was the manufacturing center of the globe, wages and saving rates rose supporting consumption while household debt, a detraction from consumption, remained at fairly low levels. During the secular period of the 80-90’s consumption was spurred by a massive increase in household credit while inflation, wages, and saving rates declined. Today, there is little ability for households to releverage themselves to support the consumption growth necessary for a continued and sustained secular period.
Economic growth is also another missing factor to the “secular” backdrop. During the 40-60’s economic growth not only averaged above 6% annually, it was also in a steadily rising trend the supported higher levels of inflation, wage growth and overall economic prosperity. While the secular bull market period of the 80-90’s witnessed slower economic growth it still remained above 4% as a surge in consumer credit, to fill the gap of rising living standards, drove consumption sharply higher (shown above). Today, with economic growth averaging just a bit more than 2% annually since the turn of the century, a primary driver of sustained returns is missing if the impact of Central Bank interventions is removed.
Lastly, employment is what ultimately leads to higher rates of sustained economic growth, consumption and earnings for companies. Potentially the largest problem with the secular bull thesis currently is the structural shift in employment. Currently, there are more American’s out of the labor force calculation, and on some form of government assistance, than ever before. To remove the argument of “baby boomers are retiring,” I have stripped out individuals above the age of 55 to examine the employment-to-population ratio of individuals of prime working age (16-54.)
Could we be at the cusp of a new secular bull market as Sam suggests? That is really for you to decide.
However, my concern is that despite much hope that the current breakout of the markets is the beginning of a new secular “bull” market – the economic and fundamental variables suggest that this may not yet be the case. Valuations and sentiment are at very elevated levels which is the opposite of what has been seen previously. Interest rates, inflation, wages and savings rates are all at historically low levels which are normally seen at the end of secular bull market periods.
Lastly, the consumer, the main driver of the economy, will not be able to again become a significantly larger chunk of the economy than they are today as the fundamental capacity to releverage to similar extremes is no longer available.
While stock prices can certainly be driven much higher through global Central Bank interventions, the inability for the economic variables to “replay the tape” of the 80’s and 90’s increases the potential of a rather nasty mean reversion at some point in the future. It is precisely such a reversion that will create the “set up” necessary to start the next great secular bull market. However, as was seen at the bottom of the market in 1974, there were few individual investors left to enjoy the beginning of that ride.