John Mauldin is far too much of a gentleman to say “I told you so,” but he would certainly be within his rights to do so.
When Mauldin published the original Bull’s Eye Investing in 2003, he made his case that U.S. stocks were in the early stages of a secular bear market. Today, nearly a decade later, he has been proven largely correct. The S&P 500 is still below its 2007 all-time high and, far more significantly, still below the previous high set after the secular bull market of 1982 – 2000. Adjusted for inflation, investors that held throughout this period would be sitting on some stinging losses.
The Little Book of Bull’s Eye Investing, published in 2012, is a shorter, more digestible update to Mauldin’s original magnum opus. And Mauldin is adamant that, despite his belief that the secular bear still has a few years left in it, the book is not about “doom and gloom,” and “the world as we know it is not coming to an end.” There is money to be made; it just so happens that you might have to look in unfamiliar places to find it.
Let’s start with a few definitions. A secular bear market is a long-term period in which stock prices are flat or falling. In practice, this has been anywhere from 8 to 20 years, with approximately 17 years being the average of the past century.
Investing in a secular bear is very different than investing in a secular bull. As Mauldin writes,
In secular bull markets, an investor should search for assets that offer relative returns—stocks and funds that will perform better than the market averages. If you beat the market, you’re doing well…
In a secular bear market, however, that strategy is a prescription for disaster. If the market goes down 20 percent and you go down just 15 percent, you’d be doing relatively well, and Wall Street would call you a winner… But you are still down 15 percent.
In markets like these we face today, the essence of Bull’s Eye Investing is to focus on absolute returns. Your benchmark is a money market fund. Success is measured by how much you make above Treasury bills.
Mauldin sees another five to six years of secular bear market conditions, “in terms of valuations, if not in price.”
This requires a little explaining. In a secular bear market the price of most stocks falls or stagnates, but price is less significant that valuation. A stock that cost $500 can be “cheap,” just as a penny stock can be “expensive.”
Value has to be measured relative to something—such as earnings, revenues, cash in the bank, or accounting book value. In a secular bull market, investors become more and more optimistic about the future earnings potential of stocks and assign them higher and higher valuations, often to the point of absurdity. By the time the S&P 500 reached its top in early 2000, the average price/earnings multiple was over 30, and it was not uncommon to see multiples of well over 100 on popular technology stocks.
But in a secular bear market, this works in reverse. Investors get progressively more skeptical of future growth and assign lower and lower valuation multiples. Today, more than twelve years after the last secular bull ended, the average price/earnings multiple is 15. That is less than half of the 2000 high.
Interestingly, throughout the cyclical bull market of 2003-2007 (in which the S&P 500 hit a new all-time high), valuations continued to shrink. To keep things in perspective, had valuations remained at 2000 bubble levels, we would have seen the S&P 500 priced at 4,000-5,000—and the Dow Industrials priced at 40,000 or more.
Mauldin recognizes that markets go through long cycles of expanding and contracting valuations. But this is distinctly not the advice you are going to get from Wall Street or from most financial advisors. Instead, they use modern portfolio theory (or, in Mauldin’s words, a “rigged” or “twisted” version of it) to justify a buy-and-hold investment plan under any and all scenarios. After all, stocks “always” generate 7-10 percent returns over the long term.
Unfortunately, the “long term” can be very long indeed, particularly if you are in or near retirement.
Mauldin on Market Psychology
“The new era economists argue that we are now smarter than our fathers, something I understood implicitly when I was in my 20s,” Mauldin writes. “ Since then, as the father of seven kids, six of whom are older than 18, I have developed doubts.”
Speaking facetiously, Mauldin writes that “our emotional forebears invested without the wisdom that we now possess. They didn’t understand that markets will go up eventually and that all you need to do is buy and hold and not worry about corrections and other transient phenomena.”
And naturally, we now have a smarter and more experienced Federal Reserve to step in and save us when need be.
All of this sounds good, of course. We do know more about economics and about the workings of capital markets than our counterparts in prior generations. But ultimately, it doesn’t matter as much as we would hope. As Mauldin makes clear, emotion drives the stock market.
The biggest factor driving stock returns, in Mauldin’s view, is not earnings growth or underlying economic conditions. It is investor perception of these, and as investors lose faith in the ability of equities to generate high returns, their selling creates a self-fulfilling prophecy that takes years to fully play out. Thus, we have secular bear markets.
How To Invest in a Secular Bear
“The essence of Bull’s Eye Investing is quite simple,” Mauldin explains. “Target your investments to where the market is going, not to where it has been.”
Fair enough. But what about specifics?
Mauldin has a couple recommendations:
Finally, Mauldin’s best advice, as a confessed “serial entrepreneur,” is to consider starting your own business if you have a good idea and have the endurance to see it through to the end. Even in a low-growth “muddle through” economy, there are new opportunities. It is simply a matter of finding them and exploiting them.
The Little Book of Bull’s Eye Investing is a nice, succinct primer on John Mauldin and his approach to the investing process. It offers no quick fixes or get-rich-quick advice, but it is a good book to keep readers grounded in reality. I keep a copy on my bookshelf, and I recommend it to readers today.
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