It looks like we may have just touched the bottom of Round 2 of this multi-year secular bear market. The first one was in 2003. Even though the last two secular bear markets (1930's & 1970's) the PE reached an all time low of around 7 times earnings. While, the current PE on the broad market is just around 13 today, it doesn't look like it will fall all "off the cliff' again like in last November to extreme low valuations, not just yet. And here's why.
Using the Robert Shiller data for it's historical PE on the S&P500 that dates back to 1871, we can extrapolate some useful information about how the market gets valuated during secular bear markets. We use the Shiller data because it uses a 10-year running earnings to normalized abnormal short-term fluctuations.
Look at the first chart, you can see the PE of the S&P gyrates to the upper extremes in 30's, 20's and 40's during the last 3 major secular booms ending in 1929, 1969 and 2000 respectively. During the following bear markets, PE reaches lows of about 7 times earnings. Coming back to the present, the current PE is only at 13. So you must think that there is more room to go down before we hit the bottom. If that's the case, the S&P should go down to 400-level which would be absurd.
Let's look at the second chart. I have broken down the 3 secular bear markets in the last 100 years.
· Bear #1 1929 - 1949 lasting 20 years
· Bear #2 1969 - 1982 lasting 13 years
· Current Bear #3 2000 - present (8 years so far)
During each of the bear markets, the S&P has swung from a high to low and this cycle repeats again and again. With each cycle it brings the the PE valuation lower and lower. Understanding this, you will appreciate that the market does not devaluate the PE from extreme highs to extreme lows in a single sweep.
With the exception for 1929, an era where we did not have good regulations and immediate government interventions, the PE went from a high of 28 to 5. That's a 83% decline. It's unlikely this scenario will happen again in this leg of the downturn, as we see our governments around the world through monetary and fiscal measures to sustain the economies. These measures include lowering short-term interest rates to extreme low levels, multi-billion dollar bailouts, funding of infrastructure and social spendings and changes in tax and accounting policies.
So far in this second leg of the bear market, the S&P have fallen 50% from the peak to the recent low in March. I can't predict for sure if it will go any lower. Perhaps another 10 to 20% but is that a lot of risk to take? Maybe not. Since March, the market has nicely recovered about 30%. Perhaps, we'll see another brief sell-off and bringing it to another lower before a final recovery.
My guess is, in the short term, the market may try to test the bottom again (going another 10-15% lower than the March low) before making an amazing come back.
But wait, I don't think this bear market is over. As we are fuelling another major medium-term boom and bust here. The last boom was the housing market and Chinese markets. This one looks like an infrastructure boom, which again will lead to strong demands in commodities. China will continue its multi-decade boom. I think after this boom, we'll see new PE valuations of the S&P in the 7 times range.
To conclude
· We are still in a long-term secular bear market that can easily last 10 to 20 years. We are in the 9th year (Round 2).
· So while the current PE is 13, don't expect returns on equity markets to be amazing over the next 10 years until the next major secular bull market.
· The strategy is to capitalize on the next medium term bull. It looks like Infrastructure, commodities and China are the best sectors to bet.
Good luck.