Figure 2 shows just how far we had to go. P/E is on the left axis; time is across the lower axis. The chart presents all of the secular bear markets from the past century. The format is similar to that in Figure 1.
Pause for a moment to reflect upon Figure 2. Contrast it back and forth with Figure 1. Every secular bear cycle prior to our current one followed a secular bull that ended with P/E in or near the red zone. That set the starting point for every adjacent secular bear. But this time, the super secular bull of the late 1990s ended nearly twice as high — it was a major bubble. Therefore, it is realistic to expect that our current secular bear might last a lot longer or be twice as gnarly as past secular bears.
Because the Fed and other factors have kept the economy in a state of relatively low inflation, the current secular bear has ground its way back to the reality of the red zone.
What goes up, must come down. Figure 2 is noteworthy for highlighting the lofty start of the current secular bear. Now after almost fourteen years, the market P/E is down, but only into the red zone. That level, however, is not overvalued. It was overvalued in 2000 and at many points over the past decade. There were not plausible economic and financial conditions to justify P/E near 30, 40, and more.
Now, finally, the stock market is fairly-valued for conditions of low inflation and low interest rates (assuming average long-term economic growth in the future). But what about the future? If inflation remains low and stable indefinitely, then this secular bear will remain in hibernation until the inflation rate runs away in either direction.
A period of hibernation, however, does not cage the bear and allow a bull to roam. Rather, it means that investors will receive returns consistent with relatively high starting valuations — nominal total returns for the stock market of around 5%-6%. Hibernation avoids the declining P/E of a secular bear. It is the decline in P/E that causes secular bears to deliver near zero return.
Hibernation also means that there is almost no chance of better returns. Average and above-average returns require a significant increase in P/E. From the red zone, higher P/E requires an irrational bubble. That is never a prudent assumption for a financial plan.
- ZeroHedge: Is The Secular Bear About To Growl? (silveristhenew.com)