S&P vs Nominal GDP - Secular Market Changes Revealed
Tuesday, January 10, 2012 at 11:37PM S&P/Nominal GDP
**This article will have a lot of information and data in it, so please reread sections as you go along.**
Not many of you may know, but I still invest in the stock market and I do see it as a great way to build wealth over the long run. Most people see what has happened over the past 12 years and think it is a waste of time. I disagree. We are just in what is called a secular bear market, which we have gone through in the past and which we will get through eventually. When? No clue. However, this article is about trying to identify the point where we will be out of this secular bear and into a secular bull market.
I imagine your first question is: what does “secular” mean when it comes to the stock market? Well, we discuss “secular” a lot at our MGO Investment Research meetings, but we have found that not many financial advisors know what this is or are able to explain this to their clients. It is an important term to know because of your age or where you stand when it comes to nearing retirement. ”Secular”, for all intents and purposes, means “long term”. It is important to know the opposite term here as well which is “cyclical,” which means “short term.”
Now, those aren’t the exact definitions, but for the most part, that is what they mean and that is how we will use them for this post. As of right now, we, at MGO, believe we are in a secular bear market, which is a long term bear market. A lot of “experts” believe this probably started around the year 2000. Is this for sure? No, but in all likelihood, we tend to agree. Now, within secular bear and bull markets, you can have cyclical, or short term, bear or bull markets. For example, if 2000 was the actual start of the secular bear market, 2003 thru 2007 would be considered a cyclical bull market and 2008 and 2009 would be considered a cyclical bear market.
Now to get into the meat of the blog post…since 1949, which is how far back my data from Economagic.com goes, we have been in four secular markets. The first one was a secular bull market from 1949 until 1968. The second was a secular bear from 1968 until 1982. The third was a secular bull from 1982 until 2000 and the last is a secular bear from 2000 until present and still going on. Click on the link below to see secular markets going all the way back to 1877.
http://advisorperspectives.com/dshort/updates/Secular-Bull-and-Bear-Markets.php
There are many metrics one can use to see if the stock market is under or overvalued. Some of them include current P/E ratio, forward looking P/E ratio, 10 year P/E ratio, market dividend yield, etc…These are the most popular. One that doesn’t get a lot of attention, however, is one that values the total stock market (or a certain index) to the Gross Domestic Product (GDP) of the United States. It does make sense to look at this because the GDP is, basically, how the United States individuals and companies make in a year. Naturally, the value of the companies cannot drastically outperform the overall growth of the United States, theoretically, and the S&P 500 is the top 500 companies, so these tend to be more stable and safe companies to look at.
So what my friend at Economagic.com has created was a series that shows the ratio of S&P500 to Nominal GDP and it is at the link below.
http://www.economagic.com/em-cgi/data.exe/var/togdp-sp500:%28rev%29
I have also put the data in a convenient chart to show everyone what is going on with this information.
As you can see above, since 1950, the ratio has been quite high and quite low. The average, over the past 50 years, has been a ratio of 805, so as of right now, we are at about the value of where we have been historically.
So what does that tell us? Well, it basically says that if you were to buy today and if this chart is indicative of what we can expect to see, you should expect to get the average of exactly 10% per year, if you include dividends on the S&P (this is based on data from Economagic.com from 1970 until now as the information before that was not available for total returns, which includes dividends).
Well, I was literally just bored last Saturday evening around midnight when I was looking at this data and I decided to pull something from our good friend, the P/E10, Ratio which basically takes out the short term fluctuations in stock price and earnings to show the long term, 10 year average of P/E ratio in a stock market. For more information on that, read the link below…this is something we at MGO take a look at a lot and from the looks of it, this is why we believe we still have some up and down behavior to go over the coming few years.
http://advisorperspectives.com/dshort/charts/valuation/PE-ratio-overview.html?SP-and-PE10.gif
Anyway, so what I did was take the S&P/Nominal Ratio and even it out with 10 year averages to see where that curve was going to land and something interesting happened….
Now, if you look, this makes the chart looking like a moving average graph, which it basically is. The points A, B, and C are points at which the 10 year average crossed the ongoing quarterly closing average. Now…for the dates at which these points occurred…
Point A: January 1965
Point B: October 1984
Point C: October 2001
Do these dates look familiar to anyone? Yep…they are eerily close to the dates at which started either a secular bear or a secular bull market.
If you recall above (or just scroll up), 1968 was the start of a secular bear market. In this chart, point A is where the 10 year average went ABOVE the then current S&P/Nominal GDP ratio and it remained there until Point B, which is October 1984. Now, the secular bull that started in 1982 was thought to have started in August of 1982, so it is still 2 years behind BUT the hard part about secular bears and bulls is that we usually don’t realize we are into them until years into them. For example, I didn’t start hearing about being in a secular bear until 2008 when the markets started to crash and people realized that this wasn’t just a short term blip.
Going on, Point C is in October 2001. Many consider March 2000, which was the high of the market, to be the start of the secular bear market, so again, we are over a year past, but for a long time, even now, people still think we are going to be in a normal recovery and are in denial that we are in a secular bear market.
Now, does this mean that you should buy or sell ONLY at those points? Absolutely not. Look at January 2009. At that point, the value of the S&P/Nominal GDP index was 556, which was 31% lower than the historical average! I don’t care that the 10 year average was still above the current average…it was still a GREAT time to buy, with today as the reference point. There are still opportunities, especially during secular bear markets, where you can make good money over the long term by buying during bad times, like end of 2008 thru early 2009.
What this chart can show is where the LONG term prospects of the stock market are looking. Remember, the stock market doesn’t go up or down based on value in the short term. It goes up and down based on people’s perception of value, which can be horribly inaccurate and emotional. Secular bulls tend to start when people think that you can’t make money in stocks anymore and secular bears start when people think that the stock market has nowhere to go but up! (Re-read this because this may be counterintuitive to a lot of people reading this blog) Think back to recent history. In March 2000, people complained if their portfolios weren’t up 35% each year! And think about March 2009…people cried that the Dow was going to go to 4000 or lower and the S&P was going to hit 400. Did either one of those happen? Nope.
To wrap this up, being able to identify the start of secular bull and bear markets can be VERY lucrative long term. Market timing is very difficult and I am not claiming to have found the secrets to it, but I will say that this data really was interesting and was kind of an “ah ha!” moment for me when I saw the chart. I’d love to hear your comments on this matter.
Reader Comments (3)
I think this is a great analysis. It is pretty cool. I also caution anyone who is chomping at the bit to dive head first into the stock market to read John Mauldin's book "Endgame" for some additional cautionary consideration. As the president of the San Fran Fed mentioned recently in Vancouver (or Calgary - I forget) "We are still living in interesting times". He also mentioned that the Fed expects 2012 will be much like 2011 (2% or lower GDP, unemployment 8.5% - or 24% depending on whose numbers you trust and how you want to measure it). We have a dollar bubble and a government debt bubble that is unprecedented in history (on a percentage of GDP basis). The housing bubble continues to deflate and the engine of our economy is in grave disrepair. I'm still sratching my head as to how the Fed is planning on avoiding the massive potential wave of inflation we could experience if we do not begin to see growth in the economy? The EU is running their printing presses to prop up the dollar. China is propping up the dollar. They must do so to be net exporters. China has orchestrated a chinese bank stimulus program and they have a 9% GDP! What does that indicate? I don't have any answers. I'm not giving advice and I hope I am being overly cautious because it would mean the world is economically stronger. I'm just saying that "past performance is not an indication of future results". Can I get an Amen? Oh and a quiz question... Can anyone identify October 1987 in the chart? It was a calamity and a bold investment opportunity, much like March 2009. In my humble opinion, I think there will be some more opportunities on the horizon. (sarcasm alert:) If only I were a congressman or a senator with all that insider information and the protective rules to take advantage of it....
Hot off the presses:
http://finance.yahoo.com/news/china-reports-rare-decline-foreign-101759367.html
Reduced exports out of China spell contraction in China GDP. Reduced foreign reserves are an indication of a cyclical change. If China can no longer prop up the dollar, their reserves shrink more and their net exports shrink and the cycle begins. If the dollar bubble pops due to foreign governments no longer supporting the dollar - the US may resort to inflation (the hidden tax) to shrink the debt. This is very interesting, no?
Carl, of course i am sure they wont resort to inflating ourselves out of debt. I am sure it was part of the plan all along. How else are we to get out of this? The good news is, inflation is the friend to real estate.