Tuesday, February 12, 2008
Secular bear markets
We've had this discussion before as to whether stocks have been in a secular bear market since 2000. The recent market action over the last 4 months makes it a little easier to accept the fact that we are in fact in a long term bear market in paper assets. In 2000 the P/E on the S&P was over 40. Today it's down to the 14-15 area. 15 is about the long term average P/E for the market. So we aren't overvalued here by any stretch of the imagination. When the market bottomed in 02 the P/E for the S&P was roughly 27 if my memory serves me. So basically at the last 4 year cycle low the market was still extremely overvalued. What's happened? Well the Fed turned on the printing presses. That liquidity flowed not only into commodities but also into corporate earnings. So the E side of P/E's has increased. Unfortunately there has been a cost for those increased earnings. Of course one of the prices we are paying is higher inflation. However that's not the only price we are paying. It was easy money that created the tech bubble. In 2002 to 2007 easy money also created the real estate bubble and the credit bubble. Bubbles aren't sustainable. We've seen the real estate bubble collapse leave a swath of destruction in its path of falling home prices, foreclosures and home owners in dire straights. Following hard on the heels of the bursting housing market we are now watching the collapse of the credit bubble with the attendant collapse in the financial sectors. The lesson of course is that there is no free lunch. The Fed was unable to "cure" the fall of the tech bubble with easy money. All they did was create two larger bubbles that are now blowing up and in the process are affecting a lot more people than the stock market bubble popping did. We are getting a front row seat as to how secular bear markets work. There is no easy way around them. There's no quick fix. As a matter of fact all the efforts to side step the bear are just making the problems bigger and badder.One thing that you can count on from the markets is that they will swing from overvalued to undervalued over long periods of time. They don't swing from overvalued to fair value and then back to overvalued. Not once in history has this been the case. So far the market has moved from extreme overvaluation in 2000 to fair value. Mostly on the back of easy money. Now that policy is coming back to bite us in the ass. The Fed's response is more easy money. It has to go somewhere. I seriously doubt we are going to make the same mistake again so quickly and reflate either the real estate or credit bubbles. No this time the money is going to go into the commodity markets. The Fed is sowing the seeds for the next leg down in the bear. That of course will be soaring inflation. Make no mistake this bear isn't going to end until stocks become extremely undervalued, just like every other time in history. We are going to have rallies that will fool everyone into thinking that the bear has been conquered but I guarantee he won't be until his work is finished. For the last 7 years the Fed has just been feeding the bear more and more food.