2011 Outlook: U.S.

Equities Secular Trend (Part 1)

December 2010

In December 2009 we published an article entitled “Are You Prepared for Another Lost
Decade” that argued the U.S. stock market has been in a secular bear market since 2000.
Our objective now is to bring you up- to-date on our current views. Let’s begin by outlining
the characteristics of secular trends and recapping the case for a secular bear.
Background

In the last 110 years, when adjusted for inflation, the U.S. stock market has alternated
between secular bull and bear markets. These trends embrace many individual business
cycles generally lasting between 15-20 years. Secular bull markets are enjoyable because
primary trend corrections are short and shallow and each successive peak is higher than its
predecessor. They definitely reflect the belief that a rising tide lifts all boats so investors are
repeatedly bailed out from their mistakes. As a result confidence builds to excessive levels
at the peak and everyone believes they are an investment genius. Decisions considered to
be irresponsible and careless at the start of the trend are hailed as perfectly routine as it
matures. The old conservative rulebook is thrown out as investors embrace the new era
thinking that “this time is different.” One of the early results of a secular bear is to expose
careless mistakes, financial excesses, and inevitable fraud that accompanies the aftermath
of a long-term boom period. Secular bears are characterized by lower equity peaks and
troughs in successive business cycles as real purchasing value is slowly eaten away.
Secular bulls lend themselves admirably to the buy hold approach. However, an entirely
different strategy is appropriate as the secular bear unfolds. A secular bear market strategy
involves offensive tactics during the relatively brief cyclical bull markets that run counter to
the secular downdraft and defensive tactics during the devastating declines experienced
when the secular bear resumes.
The Case for a Secular Bear

The root cause of secular trends in equity prices is a generational swing in crowd psychology
from unrealistic levels of optimism to irrational extremes in pessimism. These are huge
psychological transformations and they cannot take place overnight. The structural financial
and economic imbalances that developed during the secular bull phase need to be
corrected. The very fact that they are structural, as opposed to cyclical, means that this
cathartic process involves numerous recessions and periods of slow economic growth
before a new secular bull market can get underway. It is this slow and painful adjustment
process that grates on investor psychology, so that after many false dawns equities are

Pring Turner Capital Group

1600 S. Main Street #375
Walnut Creek, CA 94596
(925) 287-8527
www.pringturner.com
 2011 Outlook: U.S. Equities Secular Trend (Part 1) – A Publication of Pring Turner Capital Group

totally sold out. There are several signs that help us determine when a secular bear has run
its course.
1. Duration

The requirement for time is demonstrated by the fact that since 1900 the average secular
bear market in the U.S. has averaged just over 18-years. The Japanese market is a leading
indicator in this regard, and has been in a secular bear since 1989. If, with the benefit of
hindsight, 2009 turns out to be the ultimate low this trend would have lasted 20-years. In
either case the 10-years that have transpired since the 2000 secular peak in U.S. equities is
relatively brief by historical standards.
2. Economic Adjustment

The red highlights in Chart 1 represent recessions. It is fairly evident that these periods of
economic contraction are fairly rare and usually brief during secular bull markets.
Chart 1 Deflated U.S. Stock Prices and Two Valuation Measures 1890-2010

On the other hand secular bears have experienced between 4 and 6 recessions before they
have successfully run their course. The implied persistent economic challenges brought
about by these conditions have served two functions. First, to gradually squeeze out the
economic excesses; and put the economy on a firm foundation for a more sustainable
growth path. Second, to totally demoralize investors which sets up the psychological
foundation and the bargain level stock prices to launch a new secular bull market. In that

Pring Turner Capital Group

www.pringturner.com

Page 2 of 8
 2011 Outlook: U.S. Equities Secular Trend (Part 1) – A Publication of Pring Turner Capital Group

context, the two recessions we have experienced since 2000 have not been enough to
achieve either objective.
3. Psychological Adjustment

Since psychology is such a significant element in the identification of secular extremes and
reversals it is important that we have a means of measuring it. Fortunately we have a long
history of valuation measurements, which are really another way of looking at sentiment.
Two of them are shown in Chart 1. Arguably the most popular long-term measure of stock
market valuation is the price investors are willing to pay for corporate earnings (Price to
Earnings, or P/E Ratio). Why, at one time, are fearful investors only willing to pay $6.64 for
$1 of earnings, (i.e. 1982 Secular Bottom) while at another time they can’t get enough when
the price has moved up to an irrational $44.20 for that same $1 of earnings (i.e. 2000
Secular Peak)? The answer lies in the extremes of confidence or lack thereof, only seen at
major secular turning points. Take a moment to study the 1Shiller P/E series at the center
panel of Chart 1. At the beginning of secular bear markets, the average P/E ratio is 31.5
(confidence high), in contrast the average P/E ratio at the end of these periods is 6.95
(confidence low). The current December Shiller P/E reading is 22.7, just above the red
danger line at 22.5. We may have traveled a long way from the 2000 historic overvaluation
peak (P/E 44), but clearly there is a long way to go to reach truly undervalued levels. The
same sort of observation can be made for dividend yields, which at a current 1.96% are well
below the usual 6-7% levels seen at previous secular bottoms.
4. Valuation

Finally, Chart 2 shows the Tobin Q ratio, which measures the value of all listed companies
divided by their replacement value. It was kindly provided by Doug Short at dshort.com , a
web site we recommend for original research. You can see that the ratio was around 1.1 in
December. That might appear as fair value but the average at the three previous secular
lows was about .3. In other words at secular lows the market typically sells at just under one
third of its replacement cost.
Some argue that "risk free" treasury yields are currently well in excess of the dividend yield
on stocks, which makes equities undervalued. However, the whole point concerning secular
trends is that they reflect a swing in long-term psychology. Bottoms are formed when
sentiment is so negative that equity investors demand an exceptionally high earnings and

1
Noted Economist Robert Shiller uses a proprietary 10-year average P/E ratio to smooth out the volatile business cycle effects on
earnings. This data can be found at http://www.econ.yale.edu/~shiller/data.htm

Pring Turner Capital Group

www.pringturner.com

Page 3 of 8
 2011 Outlook: U.S. Equities Secular Trend (Part 1) – A Publication of Pring Turner Capital Group

dividend yield in order to be compensated for the risks, which are perceived to be
extraordinary. Even after 10-years of equity price erosion these three valuation
benchmarks remain closer to a peak than an important bottom.
Chart 2 Tobin Q Ratio

Based on the length of previous secular trends and valuation levels seen at their
termination, our best guess, and that’s all it is, is that the current secular bear is likely to last
until the middle or more likely end of the current decade. Chart 3 compares its path to the
average of the three previous secular bears.

Pring Turner Capital Group

www.pringturner.com

Page 4 of 8
 2011 Outlook: U.S. Equities Secular Trend (Part 1) – A Publication of Pring Turner Capital Group

Chart 3 Comparing Secular Bear Markets

If the current bear does follow the average path in a broad sense, our historical study
suggests 2011 could be a challenging year. We are in no way predicting that a new down leg
to the secular bear is about to get underway because that would require evidence of a new
emerging cyclical bear and that is not yet on the table. What we are saying, is that
confidence is still excessively high by traditional standards, valuations are still too expensive
and therefore, investors need to be on alert for a resumption of the secular bear trend.
This is also suggested by Chart 4 (next page) which compares the inflation adjusted Nikkei
with the S&P moved forward by 126-months so that their secular peaks coincide. In this
instance we have shaded the period between the turning points to indicate that these
overlay charts are not exact fits. However, using the Japanese time scale on the X axis the 3-
month 1998 and 11-month 2000 experience suggest a range that we could be reasonably
expected if the pattern is to continue. Since, in terms of its secular bear market duration,
the blue Japanese series peaked three months ago that places the timing for the resumption
of the U.S. secular bear market between January and August.

Pring Turner Capital Group

www.pringturner.com

Page 5 of 8
 2011 Outlook: U.S. Equities Secular Trend (Part 1) – A Publication of Pring Turner Capital Group

Chart 4 Comparing the U.S. and Japanese Secular Bear Markets

Past secular bear market patterns in both the U.S. and Japan suggest a potential turning
point for the start of a new cyclical bear market sometime in 2011. This pattern roughly
matches up with the continuation of the secular bear market. We are paying close attention
to our barometers and models to help us confirm the timing of an ultimate cyclical market
peak.
Be Alert for: Higher Interest Rates and Lower Bond Prices
One possible factor that markets are going to have to deal with is the probable emergence
of a secular bear market in bond prices. For the first time in 30 years, investors may have to
deal with higher and higher yields, and lower and lower bond prices. In that respect Chart 5
(next page) shows that when both the yield and the ROC have violated their respective
trend lines the secular trends of yields has reversed. At the present time U.S. Government
30-year Bond yields are very close to triggering a fourth such secular reversal since 1880 by
crossing above the green down trend line and 96-month MA, which are both around 4.65%.
However, since that has not yet happened we cannot call a turn even though we believe the
odds favor a reversal this cycle. For further analysis on the secular trend for bonds see our
special reports Are You Prepared for A Secular Bear Market in Bonds and The Road Ahead: Is
it Inflation or Deflation?

Pring Turner Capital Group

www.pringturner.com

Page 6 of 8
 2011 Outlook: U.S. Equities Secular Trend (Part 1) – A Publication of Pring Turner Capital Group

Chart 5 U.S. Government Bond Yields 1880-2010

Summary
So far in this secular equity bear market it has been relatively easy for risk-averse investors
to hide in bonds. However, if, as we expect bond prices have also begun a secular decline
passive investors will suffer as both equities and bonds decline in price especially in inflation
adjusted terms. Buy and hold, indexing, and static allocations may work in a secular bull
market but they are losing strategies in a secular bear market. In the current environment it
is more important than ever to pay attention to the business cycle for financial success.
Essentially, an investor needs two games plans, one for defense, to protect assets in difficult
periods and one for offense, to grow wealth during favorable conditions. A prudent and
profitable investment strategy should be flexible enough to actively adjust portfolio asset
allocations, depending on where we are in the business cycle and the direction of the
secular trend. With knowledge of business cycles, secular trends, and tactical asset
allocation, it is possible to create better returns with less risk and most importantly to
experience financial peace of mind.

Pring Turner Capital Group

www.pringturner.com

Page 7 of 8
 2011 Outlook: U.S. Equities Secular Trend (Part 1) – A Publication of Pring Turner Capital Group

How is Pring Turner Unique? View our Brochure

About Pring Turner Capital Group

Pring Turner Capital Group is a registered investment advisor, providing highly personalized investment
management services on a fee-only basis since 1977. The three managing partners, Martin Pring, Joe
Turner, and Tom Kopas combine for over 110 years of professional investment experience. Martin Pring is
author of numerous highly acclaimed books regarding market analysis and business cycles, including
Technical Analysis Explained, The All-Season Investor, and his most recent The Investor’s Guide to Active
Asset Allocation. Please visit our website www.pringturner.com to sign up to receive our latest research.

*Pursuant to the provisions of Rule 206(4)-1 of the Investment Advisers Act of 1940, we advise all readers that they should not
assume that all recommendations made in the future will equal that referred to in this material. Investing in securities involves
risks, including the possibility of loss. Performance numbers include all retirement accounts. Performance includes total return
(capital growth and dividends, after all costs)

Investment decisions formulated by Pring Turner Capital Group, Inc. are based on proprietary research and methods developed
since 1977 by the owner/managers of the firm. None of the material contained herein is intended as a solicitation to purchase or
sell a specific investment. Readers should not assume that all recommendations will be profitable or that future performance
will equal that referred to in this material.

Pring Turner Capital Group

www.pringturner.com

Page 8 of 8