Long-term valuation analysis suggests that we are still working through the aftermath of the highest level of stock market valuation in history — the peak of the tech bubble in 2000 — and that this workout process will take at least another five to ten years.
Over the past century, the market has gone through distinct “bull” and “bear” phases. These, on average, are 10 to 25 years each. Specifically:
- A 29-year bull market from 1900-1929
- An ~20-year bear market from 1930-1950
- An ~15-year bull market from 1951-1966
- An ~15 year bear market from 1967-1982
- An ~18 year bull market from 1982-2000
- An ~? year bear market from 2000-?
Some people think the latest “bear” phase ended in 2009. They also think we’re in the middle of a glorious “bull” phase again.
The bulls look at this chart and point out that we moved sideways for ten years after 2000, say that was plenty and predict that stocks will now forge even higher for years as the new bull market continues.
Bears, meanwhile, look at the chart and see a temporary, Fed-fueled spike in the middle of a long bear market that they believe will see at least one more big downtrend and correction (likely lasting years) before it is done.
So who’s more likely to be right? Well, let’s add more information to that chart.
Throughout history, stock prices have loosely gravitated around the “fundamentals” of the underlying companies — namely, earnings. Specifically, stocks have traded in a range of 5X cyclically adjusted earnings (at bear market lows) to 44X earnings (at the peak of the biggest bull market in history — the one that ended in 2000). The “average” P/E ratio over this period, meanwhile, has been about 15X.
When you add P/E ratios to the charts above, you quickly notice a pattern:
- Sustained bear market periods have begun when the P/E is very high (~25X+).
- Sustained bull market periods, meanwhile, have begun when the P/E is very low (5X to 9X).
In other words, sustained bull markets begin when investors are so disgusted by stocks — and so pessimistic about the future of stocks — that they’ll pay only 5X to 9X earnings for them. Sustained bear markets begin when investors are so giddy with excitement about stocks and the prospects for stocks that they’ll happily pay 25X earnings or more for them.
So, what does all this tell us?
Nothing conclusive, unfortunately. No one knows the future.
Let’s make a couple of observations about our current situation:
- First, even after the recent market wobble, stocks are still more expensive than they have been at any time in the past century with the exception of 2000 and 1929 and we know what happened after those years. For the “new bull market” to continue indefinitely, the market’s P/E would have to continue to keep rising toward the P/E at the historic 2000 market peak — which, it is worth noting, was followed by a devastating crash.
- Second, if we are indeed in the middle of a new bull market, the bear market “workout period” following the 2000 peak would have been one of the shortest in history and we were starting from the highest valuation in history, by a mile.
Unless something has changed that makes the past 115 years of market history irrelevant (always possible, but probably not likely), it would not be surprising if the biggest bull market peak in market history was followed by one of the biggest bear market workouts in history — one that, perhaps, might last as long or longer than any major workout period to date.”
When the market is expensive, like today, hedge your equity exposure and/or raise some cash. The cost is small relative to the risk that comes in expensively priced markets. Also, when interest rates are low today, increase your weightings towards alternatives (defined as anything other than traditional stock and bond buy and hold). You want to be in a position to take advantage of the opportunities inexpensively priced markets bring you. Mainly, much higher forward annualized returns.