It’s
Not Over Till the Fat Lady Goes on a
P/E Diet
By John Mauldin
Jul 10,
2015
For
the vast majority of investors, portfolio returns are generated by the equity
markets or at a minimum heavily influenced by the equity markets. We have
enjoyed an almost six-year bull market run in the stock market, which has
helped heal portfolios after the devastating market crash of the Great
Recession. So much so that many prominent market analysts have proclaimed the
beginning of a new secular bull market. If we have indeed entered such a new
phase, we need to recognize it for what it is, because – as I’ve written for 17
years – the style of investing that is appropriate for a secular bull market is
almost the exact opposite of what is appropriate for a secular bear market. I
think that most analysts would agree with that last statement. The
disagreements would revolve around whether we are in a secular bull or a
secular bear market.
Thus
the answer to the seemingly arcane question of whether we are in a secular bull
or bear market makes a great difference in the proper positioning of your
portfolios.
And getting it wrong can have serious consequences.
Towards
the latter part of the ’90s and especially in the early part of last decade, I
was rather aggressively asserting in this letter that we should look at whether
we are in a secular bull or bear market – not in terms of price but in terms of
valuation. Early in that period, Ed Easterling of Crestmont Research, who was
then based in Dallas, reached out to me; and we began to collaborate on a
series of articles on the topic of secular bull and bear markets, a series that
we want to continue today. Longtime readers know that I’m a big fan of Ed’s
website at www.CrestmontResearch.com.
It’s a treasure trove of fabulous charts and data on cycles and market returns.
Ed has been working on a video series (we will offer a few free links below) to
explain market cycles.
I
want to provide a little current context before we jump into the argument about
whether we are in a secular bull or bear market. For some time now, I’ve been
saying that the US economy should bump along in the Muddle Through range of
about 2% GDP growth. The risk to that forecast is not from something internal
to the United States but from what economists call an exogenous shock, that is,
one from outside the US. In particular I have said that a crisis in both Europe
and China at the same time would be very negative for both US and global
growth. We now see potential crises in both regions. It would be convenient if
they could arrange not to have them at the same time. But those who are paying
attention to global markets are certainly experiencing a bit of market
heartburn as they watch both China and Europe manifest the volatility that they
have over the last few weeks. I will become far less sanguine about the US
economy if full-blown crises develop in those two regions.
There
are observers who think the Greek crisis will be contained, and then there are
equally astute but pessimistic observers, like Ambrose Evans-Pritchard, who
wrote this week about the potential for a full-scale European meltdown. His
recent column entitled “Europe
Is Blowing Itself Apart over Greece – and Nobody Seems Able to Stop It” is
reflective of those who think the European monetary experiment is problematic.
It now appears that Tsipras has essentially caved on a number of issues in
order to get a deal. The deal he has proposed reads almost exactly like the one
the Greek referendum overwhelmingly rejected.
My
own personal view is that, if this deal is agreed upon, it simply postpones the
crisis for a period of time, as Greece simply has no way to grow itself out of
its debt dilemma. And it is not altogether clear that Tsipras can hold his
coalition together, given the referendum. He might actually need the opposition
to get this deal passed, which becomes problematical for him, as it might force
him to call an election. But the banks would open, and Greek life would go on
until the Greeks run out of money again in the sadly not-too-distant future, as
there is no way on God’s green earth they can meet the growth requirements that
this deal demands.
The
monetary union is an absurd creation based on political hopes, not economic
reality. Politics can keep it together for longer than it should otherwise
exist, but unless the entire southern periphery of Europe turns German in
character, the peripheral nations are going to suffer under a monetary policy
not designed for their economies. That ill-fitting economic straitjacket is
going to mean slower growth and higher unemployment and fiscal instability. How
long will they endure that? So far, a lot longer than I thought they could, 15
years ago.
China’s
stock markets are having a meltdown, although there has been a rebound the last
few days as the Chinese government has stepped in with the decision to destroy
their markets in order to save them. My friend Art Cashin commented that it is amazing
what you can do if you tell people that they will either buy stocks and make
them go up or get executed. It certainly clarifies your trading position.
Further, the Chinese government basically created a rule which said that
anybody who owns more than 5% of any particular equity issuance is not allowed
to sell for the next six months. Neither are directors, supervisors, or senior
management of any public company. The government has evidently pressured banks
into creating a buying consortium. Historians who are familiar with the stock
market crash of 1929 will see an interesting parallel, illustrated in the chart
below (sent to me by my friend Murat Koprulu).
Hundreds
of Chinese stocks have been taken off the market because they are essentially
locked limit down or because company management simply halted trading in their
shares, as there seemed to be no bottom to the pricing. That is an interesting
way to run a supposedly liquid equity market exchange. And it creates an
overhang, in that, under the current rules of the exchange, those hundreds of
stocks have to go back on the market within 30 days. Theoretically, they were
falling in value, which was why they were taken off the market to begin with.
Will their valuations somehow magically change?
I
wonder if all the major indexing firms are happy with their recent decisions to
include China as a major portion of their indexes, given that liquidity in
their markets is available only when markets are going up. Just curious, but
how in the Wide, Wide World of Sports do you price or even maintain an index if
you can’t sell and have daily liquidity and price discovery? If 7% of your
index is based on a valuation that is not real, what price do you then base
daily liquidity on? The last trade? So the seller gets out at a price that
might be significantly higher than what the issue would actually trade at? Who
sues whom? Or maybe the issue then trades higher, not lower, so that the seller
should have
gotten more? Index fund managers have to be pulling their hair out over this
one.
Is
this collapse of the Chinese market just the result of irrational exuberance,
or is there something more fundamental going on? We will have to watch the
situation carefully in the coming weeks.
By
the way, China is far more critical to the global economy than Greece is. So
much so that I recently asked a number of my friends to give me their best
thoughts on China. These are experts in markets, demographics, economics,
geopolitics, and so on, all with specialties in China. I’ve compiled those
thoughts along with my own and those of my co-author, Worth Wray, in an e-book
called A
Great Leap Forward? You can get it on Amazon, iTunes, and Nook
for a mere $8.99. It is an easy read that will give you an understanding of
China’s challenges, from the best China experts we could find. Now, let’s talk
about where the market is going in the US.
By
John Mauldin and Ed Easterling
We
were both talking about secular bear markets back in 1999 and 2000. It’s been
15 years. Aren’t we there yet? Isn’t the stock market rising?
Of
course you’re getting impatient; so are we. When will the stock market shift
from secular bear to secular bull – or did it already? The implications are
significant.
Through much of the 2000s and into the 2010s, individual and
institutional investors have weathered quite a storm of low returns and high
volatility. Are we done
being battered? From today, can you reasonably expect above-average
secular bull returns like we saw in the 1980s and ’90s … or do we face another
decade or longer of below-average secular bear returns? [For a 3-minute video
explaining the term secular,
click this
link.]
In
short, we use secular
to describe a particular valuation environment. If you use valuations as a tool
for thinking about cycles, the cycles become much more clear and easily
understandable. Simply using price gives you no objective criterion for
determining where you are in a long-term cycle. Within our longer-term secular
designations there can be numerous and significant cyclical bull and bear markets, which are
determined by price and not valuations.
For
years, analysts and pundits throughout the industry have agreed (though it took
a number of years for many of them to come around) that the new millennium
brought with it secular bear conditions. In the past few years, however,
opinions have once again diverged. Notable heavyweights, including Guggenheim
Investments, Raymond James, and BofA Merrill Lynch, are on the record that the
stock market has now entered a long-term secular bull market. (They are
certainly not the only ones, but they do provide nifty charts that make it easy
to analyze their thoughts.)
As
shown in Figure 1, Guggenheim clearly marks the transition point between the
end of the secular bear that got underway in January 2000 and the start of the
new secular bull market. They place that transition point at December 2010, so
that by their reckoning the secular bear lasted eleven years and produced
near-zero annualized returns. Then, according to Guggenheim, a new secular bull
market was unleashed with New Year 2011.
Figure
1. Guggenheim Secular Bull Started January 2010
| From today, can you reasonably expect above-average secular bull returns
like we saw in the 1980s and ’90s … or another decade or more of
below-average secular bear returns? |
Now,
four years and a cumulative +54% later, the Guggenheim chart appears to lead
investors to expect a future of above-average secular bull returns. They are
somewhat subtle about it: note the implicit investment advice in the upper-left
area of the chart: “Investment strategies that work in bull markets may not be
effective in flat or bear markets.”
So
true! So pertinent to this article! In the next five or ten years, will the
market surge ahead from the modest uptrend of the past four years, or will the chart
action simply blend into the previous eleven-year secular bear? You’re probably
not reading this article and others like it for entertaining chart designs; you
likely want insights about how to position your portfolio. Okay, so what’s most
likely for the next five or ten years: secular bull or secular bear? On to that
in a moment, but first let us observe that Guggenheim is not alone in their
outlook.
In
Figure 2, [John’s good friend] the very savvy Jeffrey Saut at Raymond James
marks the start of the new secular bull somewhat later than Guggenheim does.
Based upon the chart’s legend and the notation that the previous secular bear
lasted “13+ years,” Saut appears to call the transition in 2013.
Figure
2. Jeffrey Saut and Raymond James Have the Bull Greening Up in 2013
Saut’s
secular bull green shoots are still developing roots. Nonetheless, his chart
does lead the observer to hope that the right margin of the chart will fill
with rising green lines. His way of designating secular periods results in an
average term of about 14 years – so just over one down and around 12 to go for
the new bull!
Last,
yet clearly not least, in Figure 3 BofA Merrill Lynch completes the trifecta of
secular bull market prognostications. The text in the upper part of the chart
reads:
This
chart is bullish longer term, but there is the risk of a parting shot from the
bears (cyclical bear market within a secular bull market) and a 1982-style
buying point for the US equity market using the overlay of the S&P 500 off
the 1942, 1974 and 2009 generational lows as a guide. This overlay chart lines
up generational lows and suggests an increased risk of a cyclical (NOT secular)
peak later this year and a drop into year-end as well as next year, especially
if the US equity market follows the incumbent Presidential Cycle pattern.
However, strong advance-decline lines do not suggest that a cyclical peak is
imminent.
BofA
Merrill says that we’re in a secular bull market but that the best
opportunities are still on the horizon – the near horizon! So 2015 or 2016 will
see a pullback during which we should load the boat for a decade when, they
predict, the stock market will double or triple in value. And while predicting
a double or triple over the longer-term is optimistic, note that they are
suggesting the market may return to levels seen at the beginning of 2000, a
trajectory which to us seems more like a continuation of our secular bear cycle.
We
fully agree that at some point the markets will double and triple. The question
is, when does the runup start, and what do we do before that starting point?
Figure
3. BofA Merrill: Secular Bull More Than Doubling Over the Next Ten Years
If
you are reading this article, you are likely a savvy investor with a few
lessons of history (and losses of experience!) under your belt or as scars on
your back. You are likely starting to feel a few contrarian hairs tingle on the
back of your neck as you look across the oceans at Europe and China. You may
even be seeing a few flashes of falling knives from the upcoming pullback
suggested in Figure 3. So let’s explore the alternate view and the implications
for investment strategy and portfolios.
Secular
stock market cycles are long-term periods of above- and below-average returns.
These longer-term periods consist of many shorter-term “cyclical” periods.
During secular bull markets, the cyclical cycles occur along a generally rising
path that features higher highs and higher lows. Thus in secular bull markets
cyclical bulls surge, and cyclical bears are often somewhat muted.
During
secular bear markets, however, the market’s path is generally sideways. As a
result, the cyclical bulls and bears tend to be more balanced, with the bulls
reversing the declines of bears and bears offsetting the runs of the bulls. The
net result of these offsetting cycles is an extended period with disappointing
cumulative returns.
Figure
4. Crestmont Research: Secular Bear Remains; No Chance of Secular Bull
In
contrast to the secular bull outlook from Guggenheim, Raymond James, and BofA
Merrill, we believe – without hesitation or doubt – that the data shows the
current cycle to be the continuation of a secular bear market, as shown in
Figure 4. Further, we have a strong conviction that absent a dramatic crash and major deterioration in
inflation-rate conditions, the prospect of a secular bull is far away. [For a
5-minute video discussing the “Secular Stock Markets Explained” chart above,
click this
link.]
The
most significant difference across the four secular charts presented thus far
is that the Crestmont chart prominently includes what we believe is the true
driver of secular stock market cycles: the price/earnings ratio (which is, in
turn, influenced by inflation, as we will explain below). Note the blue line
near the bottom of the chart. The wavy price/earnings ratio (P/E) cycle
reflects the level and trend of stock market valuation. Red-bar secular bear
markets are driven by a declining trend in the P/E, and green-bar secular bulls
are driven by a rising P/E trend. Neither time nor magnitude are relevant.
You
can’t really have a secular bull market without rising price-to-earnings
ratios. You can have some astounding cyclical runs that will eventually return
to valuation-constrained averages, but the markets of the ’80s and ’90s
required an ever-rising price-to-earnings ratio, as has every other bull market
in the past.
Anybody
who declares that we are in a secular bull market today is singularly focused
on price, which is a derivative of the actual driver of market returns. It is a
secondary relationship that is derived from valuation.
Secular
stock market cycles are not driven by time-dependent phenomena. There is no
mystical or explainable term of years over which the market rides waves of
bulls and bears. (There are some interesting coincidences here and there but
certainly not enough data points to draw any firm conclusions.) Some chart
designers conveniently shift years or combine periods to create such an
apparent effect, yet time is not a reliable driver of these periods. (For the
most part, none of the previously displayed secular charts resort to this
technique.)
Likewise,
secular stock market cycles are not driven by magnitude; they don’t start and
stop at new highs or lows (or relate to certain levels of gain or breakeven).
If such a methodology were consistently applied to longer-term secular cycles,
the results would be disappointing. That said, the shorter-term cyclical cycles within
secular cycles can often be well defined using such a technique. Secular
cycles, on the other hand, can be understood only through an examination of the
underlying fundamental principles that drive them.
One
such principle is the P/E cycle, which is driven by the effect that the
inflation rate has on valuations. As the inflation rate rises, the present
value of future earnings falls. Prices (the P
in P/E) decline,
with minimal immediate effect on current earnings. Thus, as P falls and E stays
nearly the same, the result is a decline in P/E.
Deflation
also drives P/E lower. Deflation is a declining trend of future nominal prices.
A series of declining future earnings is worth less than stable or rising
earnings; thus a trend toward deflation drives P/E lower. As deflation worsens,
the value of the market (and thus P/E) declines even further.
Therefore,
a trend in the inflation rate away from low, stable inflation drives P/E lower,
while a trend in the inflation rate back toward low, stable inflation drives
P/E higher. Thus, as we see in Figure 4, the historical inflation rate cycle
drives P/E, which in turn multiplies or offsets the growth in earnings to
deliver above- or below-average returns.
Let’s
consider returns from another vantage point. Sometimes it can be revealing to
break economic concepts into their component parts in order to better
understand what drives them. For stock market returns, we have a fairly simple
machine. There are only three components that combine to provide market
returns. Any returns beyond the market return are the result of skill in
portfolio selection or management.
As
reflected in Figure 5, the three components are earnings growth, dividend
yield, and any change in P/E over the holding period. The chart includes values
from one of the most recognized series, the one provided by Professor Roger
Ibbotson and published annually in the Ibbotson
SBBI Classic Yearbook by Morningstar. The 2015 values are on pages
156-157. Through 2015 (the series starts in 1926), the cumulative annualized
total return is 10.1%. Earnings growth contributed 5.22%; dividend yield added
4.25%; and the change in P/E topped it off with 0.63%.
Figure
5. Components of Stock Market Returns
Those
historical values benefit from several factors that are not available today.
First, the Ibbotson series starts in 1926, when P/E was 10.2. Over the 89 years
since then, P/E has more than doubled. That added gains to the long-term total
return. Going forward, however, another doubling of P/E from the currently high
level is very unlikely.
Also,
the low starting level of P/E in 1926 drove a high dividend yield in the
long-term average return. The dividend yield is dividend dollars divided by
market price index.
For the S&P 500 Index, for example, the dividend yield
is the total dividends of all 500 companies divided by the market index. When
market valuation is relatively low (i.e., low P/E), dividend yield is higher
than it is when the market P/E is higher. This is a direct mathematical
relationship. The dividend yield of a market that is priced at a P/E of 10
would be twice the yield of a market that is priced at a P/E of 20 (assuming
the same dividend dollars). Therefore, since the long-term historical stock
market series starts at a P/E of 10.2, it includes a realized dividend yield of
4.25%. Had the starting P/E been at today’s level, the dividend yield would
have been only about 2.1%. Of course, for today’s investors, not only does
today’s high P/E explain why today’s d ividend yield is near 2%; it also means
that the dividend yield component of future returns will be near 2%.
What
is a reasonable expectation for future returns? For this discussion, let’s
assume that the future we are talking about is the next decade (2015-2024).
The
first component is earnings growth; let’s assess its driver. Earnings growth is
primarily driven by economic growth. Although profit margins vary across the
business cycle and by industry and company, earnings for the stock market as a
whole over the long term tend to track sales growth. Measures of the economy,
including gross domestic product (GDP), tend to measure the aggregate sales of
all companies in the economy. As a result, earnings growth has historically
been similar to GDP growth. In reality, earnings growth for large-company
indexes like the S&P 500 has been slightly lower than overall economic
growth. The economy includes faster-growth small companies and start-ups that
tend to outpace the more stable giants.
Over
the past 89 years, the inflation rate has averaged 2.93%. Earnings growth is
stated in nominal terms, with inflation adding to that component. The current
level of inflation is about half of the historical average. If the inflation
rate remains relatively low, as most analysts today believe it will, it would
reduce the future nominal growth rate (compared to the historical average) by
around 1.5%. In addition, most economists expect real economic growth (and
thereby real earnings growth) to slow somewhat into the future. As a result,
the estimate for future earnings growth is 3.5% annually, as shown in Figure 5
(and we need to remember that is in nominal terms).
Yes,
the earnings estimate does assume relatively low inflation. And yes, a higher
inflation rate would increase the contribution of earnings growth to total
return.
However, an increase in the inflation rate would have an even more
significant offsetting effect on another component. More on that in a moment.
Dividend
yield, as described previously, is highly dependent upon the level of P/E.
The
relatively high P/E ratio today portends a relatively modest dividend yield for
any period starting in 2015. As a result, Figure 5 includes a contribution of
2.0% from the dividend yield component. Further, we have to remember that
earnings as a percentage of GDP are close to all-time highs. In the past,
earnings have been mean-reverting in terms of GDP. That would suggest that
earnings growth could come under constraint over the next 10 years. There
certainly doesn’t seem to be a great deal of room for an increase in overall
earnings in terms of GDP.
The
last component is the effect of a change in P/E. An increase in P/E adds to the
returns provided by earnings and dividends; a decrease in P/E offsets those
contributions to total return.
P/E
is, in the final analysis and over the longer-term, driven by the inflation
rate.
When the inflation rate rises, the effect is an increase in interest
rates and a decrease in P/E. When the inflation rate declines into deflation,
the result is a decline in P/E. At low, stable inflation, the value of P/E
rises to its peak. With today’s relatively low, stable inflation rate, a
significant trend up or down in the inflation rate will decrease P/E.
Therefore, a positive contribution to future total return from a significant
increase in P/E is very unlikely.
Returning
to the hopes of those who anticipate that higher inflation will add to the
component of earnings growth, keep in mind that the adverse effect on the P/E
component will more than offset any gains to the earnings component.
As a
result, the near-best outlook for the next decade is an annualized total return
of approximately 5.5%.
Such a decade would essentially leave the current secular bear market suspended
in a state of hibernation. That’s because hibernation assumes
that the level of P/E does not change. As a result, at the end of the decade
P/E would remain near current levels, and P/E will be no better positioned to
double than it is today. For a transition out of secular bear into secular
bull, the market must endure the effects of a decline in P/E to levels that
will then enable it to double or triple. Such a decline would compromise the
“optimistic” outlook of 5.5% annualized returns and instead deliver near zero
return.
To
illustrate this point, let’s review a chart that highlights the course of P/E
in secular stock market cycles. Figure 6 reflects the level of P/E for each
year of the past four secular bull markets since 1900. The number on the lower
axis is the number of years in each cycle. [For a 5-minute video explaining the
Secular Market Cycles charts in Figures 6 and 7, click this
link.]
You’ll
see that P/E during secular bull markets starts in the low-P/E green zone and
treks upward to the higher-P/E red zone. In the most recent secular bull, which
ended in a secular bubble, P/E reached the red zone and then doubled again.
Regardless, this chart helps viewers to visualize that secular bull markets
require a significant increase in P/E.
Figure
6. Secular Bull Market P/E
Figure
7 presents P/E during secular bear market periods. Since bears start where
bulls end, the starting level for P/E in secular bear markets is generally in the
red zone on this chart. The obvious exception is the most recent secular bull,
whose dramatic end in a bubble gave our current secular bear quite an extra
distance to travel. And for market analysts who are anchoring their current
expectations from that last experience, the path ahead could be particularly
treacherous.
Figure
7 includes three extra lines for illustration. They represent the three likely
courses for P/E over the next decade. First, the purple line reflects a
continuation and conclusion of this secular bear. New secular bull in 2025! The
implication for the components analysis is that total return over the decade
would be near zero as the decline in P/E offsets earnings growth and dividend
yield.
Second,
the brown line reflects a secular bear in hibernation. This scenario provides
the near 5.5% annualized gain that was illustrated previously in Figure 5.
Third,
the pink line reflects a repeat of the late 1990s: a surge of P/E to
irrationally exuberant levels. Although this scenario is possible, very few
professionals (and not even the most optimistic pundits) would advocate basing
your investment portfolio and lifestyle distributions on this outcome.
Nonetheless, for the blissfully hopeful, this outlook would deliver annualized
total returns just over the long-term average of 10%. It would not repeat the
1980s and ’90s secular bull results, because the starting level of P/E is so
much higher in 2015 than it was in 1982.
Figure
7. Secular Bear Market P/E
There
is a third constituency of outlooks for stock market returns over the next decade
or so. This group of esteemed market and investment professionals doesn’t
typically speak in secular-cycle terminology but rather tends to present
forecasts for seven- or ten-year returns. Two of the more prominent members of
this group are Jeremy Grantham and John Hussman. The current longer-term
outlook from each of them indicates near-zero returns from US large-cap stocks.
This
outcome can be explained using the previous approach of dissecting the
components of stock market returns. Both Grantham and Hussman assume reversion
to the mean. That is, their forecasts include the assumption that P/E will be
at or near its long-term average at the end of the forecast period. They either
don’t see the inflation rate as the driver of P/E and/or simply believe that
the average value is the most likely level in the future.
If
P/E happens to decline to its historical average over the next seven- to
ten-year period, that downtrend will nearly offset the positive contribution of
earnings growth and dividend yield. Therefore, Grantham and Hussman implicitly
believe that we’re in a secular bear market, even if they don’t specifically
graph and describe it that way.
Conclusions on Secular Bear Markets
The
current secular bear market has lasted a long time. It’s reasonable that
investors want to return to a secular bull market environment (a sentiment that
we certainly sympathize with), but the reality is that the level of stock
market valuation (i.e., P/E) is not low enough to provide the lift to returns
that drives secular bull markets. As a matter of fact, P/E is at or above the
typical starting level for a secular bear market.
The
current situation is not the result of P/E hibernation over the past 15 years. P/E has declined by nearly the same
number of points as it has historically in a typical secular bear.
This secular bear, however, started at dramatically higher levels as a result
of the late 1990s bubble. The market’s work of the past 15 years has been to
deflate the excesses that preceded it.
It
is therefore not unreasonable to assume that it will take longer for this
secular bear to unwind than previous secular bear markets required. We started
this secular cycle with a very long way to go. We should actually be glad that
we are nowhere near the area that would denote the beginning of a new secular
bull market, because the absolute price of the stock market would be
devastating to pensions institutions and all of our portfolios.
It
is much better for earnings and overall growth to supply the “oomph” in the P/E
ratio. Of course that’s a much slower process, especially when GDP growth is in
a “Muddle Through” mode.
The
passage of time and other factors have led some very smart and respected people
to hope for, and then posit, a new secular bull. Unfortunately, the stock
market is not positioned to deliver above-average returns over an extended
period.
Going
forward, there are three scenarios. We could repeat the secular bubble of the
late 1990s, yet that seems highly unlikely. We could enter an unprecedented era
of high, flat P/E. If so, investors need to have a rational expectation for
somewhere around 5% total nominal returns. Finally, we could see the current
secular bear run the rest of its course, with P/E declining to levels that
portend a new secular bull. The unavoidable reality is that the latter scenario
means either an extended period of near-zero returns or a shorter period of
cumulative losses. The impact of a declining P/E is an offset to returns – the
longer it takes to happen, the less dramatic the effect.
We
(John and Ed) have enjoyed a great deal of discussion about possible outcomes.
John is of the general opinion that with the next recession we will see a move
to lower P/E ratios, which will bring us closer to the final end of the secular
bear market.
Ed acknowledges that this is a possible scenario but is more
agnostic as to how we actually get to that lower level. But we both agree that
the secular bear market is not over till the fat lady goes on a P/E diet.
(To
our foreign readers, that is not a derogatory saying about weight-challenged
persons but a cultural reference stemming from our mutual Texas background.
Quote: “The opera ain’t over till the fat lady sings!” – Darrell Royal, the
legendary football coach at the University of Texas.)
A
secular bear market is not a time to retreat from the market; rather it is a
time to position portfolios and expectations for such an environment. The
result can be solid investment success; achieving this success just takes a lot
more work than when we are enjoying the fruitful conditions of a secular bull.
John
here. This is the beginning of what will be a series of letters over the next
multiple months on equity investing. I’ve done a great deal of research on the
topic over the past six months, on the belief that index funds as they are
currently structured are going to be systematically and structurally
problematic for your future investment needs. In short, we are still using
indexes designed in the 1950s to determine the structure of our portfolios in a
world that is being continually challenged by changing paradigms. Even if you
are a pure long-only traditional investor, you are giving up three points or
more annually simply by your index choices. This makes a huge difference over
time. And that’s before you even begin to hedge or optimize. Or to drive down
fees.
I
am coming to the conclusion that we need a complete rethink of how we go about
the business of equity investing, not just in the US but globally. But that is
the topic for a number of future letters.
Just
for the record, since some new readers might not know who Ed Easterling is, let
me offer this brief introduction: Ed is the author of Probable Outcomes: Secular Stock
Market Insights and the award-winning Unexpected Returns: Understanding Secular Stock Market
Cycles. He is currently president of an investment management and
research firm. He previously served as an adjunct professor and taught the
course on alternative investments and hedge funds for MBA students at SMU in
Dallas. Ed publishes provocative research and graphical analyses on the
financial markets at www.CrestmontResearch.com.
I
flew home on Friday and will find myself in Denver Sunday night, having dinner
with Jack Rivkin, who has been named the new CEO of Altegris Investments. We
have been having ongoing discussions on a wide variety of topics, as we both
search for ways to express our belief that the investment world is going to
change dramatically over the next five to ten years. We would like to be part
of helping bring that change about rather than being run over by it. We are
often led to some very uncomfortable conclusions, but we are determined to get
up on our boards and surf the inevitable.
And
speaking of Altegris, the videos of the speakers at our conference are
(finally!) becoming available for your viewing pleasure. The first two feature
two of our most popular speakers, Jeffrey Gundlach and David Rosenberg. If you
are a Mauldin Circle member, you can access the videos by going to www.altegris.com
to log in to the “members only” area of the Altegris website. Upon login, click
on the “SIC 2015” link in the upper-left corner to view the videos and more. If
you have forgotten your login information, simply click “Forgot Login?” and
your information will be sent to you.
If
you are not already a Mauldin Circle member, the good news is that this program
is completely free. In order to join, you must, however, be an accredited
investor. Please register here
to be qualified by my partners at Altegris and added to the subscriber roster.
Once you register, an Altegris representative will call you to provide access
to the videos and presentations from selected speakers at our 2015 conference.
It
has been busy this week, as I’ve tried to pack in a lot of engagements during
my last few days here in New York. There were numerous meetings designed to
help me do a deep dive into different ways to slice and dice the investment
spectrum. I haven’t found any one-stop-shop solutions (surprise, surprise), but
I am beginning to see how combining a number of different and new insights
might give us a much more effective overall portfolio design. Steve Blumenthal
came over from Philadelphia; I had dinner with Gary Shilling last night at his
home in Short Hills, NJ; and I was on the radio with Tom Keene and Mike McKee
this morning. It is always interesting to be on with Tom and Mike, because no
matter how much you have prepared to talk about the topics that they’ll be
interested in, they have a knack for broadening the discussion and taking it in
an entirely different direction. Which is what makes them one of the best radio
teams in America.
It
is time to hit the send button, gather my belongings, and head to the airport.
I hope you have a great week.
Your
constantly searching for a better way analyst,
John Mauldin
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