Mining For Gold; Cyclical vs. Secular Market Cycles
I’m addicted to placebos. I’d quit but then it doesn’t matter – S. Wright
Secular vs. Cyclical Market Cycles and more
Cyclical vs. Secular Market Cycles
The P/E Report: Quarterly Review Of The Price/Earnings Ratio
by Ed Easterling, Cresmont Research
Current Status (Third Quarter 2016)
The third quarter initially surged higher and then generally maintained its ground through the quarter. In the end, the stock market added 3.3% to the year’s total and normalized P/E increased to 27.3—well above the level justified by low inflation and interest rates. The current status remains “significantly overvalued.”
The level of volatility pulled-back a bit over the past quarter; as a result, the trend for volatility is unclear over the near-term. The trend in actual and forecast earnings continues to slide. Earnings and volatility should be watched closely and investors should remain cognizant of the risks confronting a vulnerable market.
The Big Picture
The P/E ratio can be a good measure of the level of stock market valuation when properly calculated and used. In effect, P/E represents the number of years’ worth of earnings that investors are willing to pay for stocks. Although we will discuss later the business cycle and its periodic distortion of “reported” P/Es, most references to P/Es in this report will relate to the normalized P/E that has been adjusted for those periodic distortions.
Stocks are financial assets which provide a return through dividends and price appreciation. Both dividends and price appreciation are generally driven by increases in earnings. Despite the hope of some pundits, earnings tend to increase at a similar rate to economic growth over time.
Historically (and based upon well-accepted financial and economic principles), the valuation level of the stock market has cycled from levels below 10 times earnings to levels above 20 times earnings. Except for bubble periods, the P/E tends to peak near 25 (the fundamental limitations to P/E are discussed in chapter 8 of Unexpected Returns). Figure 1 presents the historical values for all three versions of the P/E discussed in this report.
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Understanding Secular Market Cycles
by Ed Easterling, Crestmont Research
The word secular originates from a series of Latin words that mean an extended period of time or an era. It is actually closer to you than you might realize. On the back of the one-dollar bill, look below the pyramid on the left; the one with the strange eye above it. The term Novus ordo seclorum means a new order for the ages, a new American era. Seclorum is the word in that phrase that means ages or era. Thus, the term secular stock market cycles relates to extended periods, or eras, in the stock market.
For the stock market, secular market cycles are generally qualified as either bull or bear cycles. Bull cycles are periods when stock market returns are good and bear cycles reflect periods of weakness.
That’s where agreement among secular stock market analysts and market pundits ends.
Too often, the concept of secular cycles is dismissed or misunderstood by investors because they are confronted with a lot of incorrect or contradictory information about these cycles. First impressions can be a powerful force. Adding to the confusion, there are at least three schools of thought about the causes or drivers of secular bulls and secular bears. The principles and theories within those schools are quite different.
This article seeks to help you to differentiate the various sources of secular stock market information and understand the basis of their positions. It will explore in detail key principles from the third school and conclude with a quantitative outlook for the stock market environment and expected future returns. This will show that secular market cycles are mathematically-driven and not phenomena or coincidences. It will also highlight the need to focus on decade-long periods and not century-long average returns.
Keep in mind as we discuss secular stock market cycles, that these longer-term cycles are distinct from the short-term cyclical cycles that occur numerous times within secular periods. The shorter cyclical cycles are driven by emotion, events, funds flows, or any number of temporary factors. Secular cycles are extended periods of longer-term trends in the stock market.
The most commonly followed school identifies secular market cycles based upon chart patterns or average length of past cycles. For example, extended periods that appear to be rising (e.g., the 1980s and ‘90s) are designated as secular bulls. Extended flat or declining periods are designated as secular bears. Alternatively, other analysts in this school define bulls and bears based upon years (e.g., 17 years for secular bears). This school has a wide range of explanations for the causes behind the cycles. They include economic conditions, major events, investor psychology, etc. to explain the phenomenon driving chart patterns or time periods. Ultimately, however, the designation of secular period under this approach can be fairly subjective or it relies upon an undefined force. This school not only has the largest following of observers; it also has the largest audience of skeptics.
See the full PDF below.