Every single secular bear market (dating back to 1870) has started with a high price to earnings (PE) ratio (into the mid-20′s) and finished a decade or two later with a single digit PE.
High PE’s reflect the elevated social mood that accompanies a long period of prosperity. Low PE’s are the end result of markets grinding investor confidence to dust over a sustained period of time.
The current US Secular Bear Market began with the bursting of the Tech Bubble in 2000. At the peak, the S&P 500 index registered a nosebleed PE of 45-times. After 13 years of ‘zigging and zagging’ the S&P 500 index is barely above the high it reached in 2000. The current PE sits around 20x.
Firstly the current average is 25% above the long term average of 16x and well above the single digit PE’s recorded at the bottom of previous secular bear markets.
Whether it’s the mathematical law of ‘reversion to the mean’ or gravity’s law of ‘what goes up must come down’, the US share market has a lot more hard yards left in it yet.
Another question to consider is, ‘Do you think the global share markets would have recovered to present levels if central banks hadn’t intervened to the extent they have over the past four years?’
Based on the recent volatility caused by Bernanke’s thought bubble on ‘tapering’, the answer to the above is, ‘NO.’
Bernanke and co are waiting on some magic employment, CPI and GDP numbers to register before they slow down the printing presses.
But what happens if, as per the argument above, the drivers of natural global growth have abated and those magic numbers don’t appear? Surely there’s a point where central bankers also hit the wall of economic reality?
This brings me to the final of Newton’s lessons – smart people doing dumb things.
Central bankers have impressive CV’s and more letters than the alphabet after their names. No question these folks have the academic smarts – however they aren’t in Newton’s league.
So if someone of Newton’s genius succumbed to the lure of the market, it’s not crazy to think Bernanke et al can also be too smart for their own good.
Bernanke’s 100% confidence (as stated to CBS’s 60 minutes) in his ability to fine-tune the economy should be the Macquarie Dictionary’s new definition of ‘hubris’.
Although the current definition will suffice for now:
‘an excess of ambition, pride, etc, ultimately causing the transgressor’s ruin.‘
In central banker world the central bankers have busily been ‘painting away’. The mainstream commentators glowingly compliment the central bankers on their brushstrokes and their wonderful work.
But none of them are looking at the totality of the project. Sometime in the near future the central bankers will realise they’ve painted themselves into a corner. This will be the ‘oh shoot’ moment as they realise what they’ve done.
Once the market loses confidence in the central bankers’ ability to manage the economy, it’s all over.
If or when we have GFC MkII (probably sovereign default) what other policies do central bankers have up their sleeve?
Negative interest rates, perhaps. But what would that do for confidence?
They could print even more money. Even though the first few trillion dollars didn’t work.
They got nothing folks.
Chaos reigns.
The pent up corrective activity that should have occurred after the GFC will be unleashed and it won’t be pretty.
Here’s a look at what happened to poor (and I mean that in the financial sense) Sir Isaac and the other shareholders in the South Sea Company in 1720-21:
The Great Credit Contraction has been slowly exerting its grip on the economy. The pushback from central bankers has temporarily obstructed its equal and opposite forces.
The point to remember is the Great Credit Contraction (together with low growth dynamics) can continue exerting their influences for far longer than central bankers can retain the confidence of markets.
We’re transitioning to a new ‘normal’. For the foreseeable future there will be lower growth, people living within their means, baby boomer retirees growing in number each year and indebted governments wrestling with how to meet increasing welfare entitlements and healthcare costs.
This is a vastly different set of circumstances to what existed at the start of the credit boom in 1980.
Now, I appreciate the above is all rather gloomy, but there’s no point putting lipstick on a pig.
However opportunity does present itself out of adversity.
The impending market upheaval will present patient and cashed up investors with the opportunity to capitalise on the greatest asset sale in their lifetime.
Buying assets at a fraction of their true value is the foundation on which to build your family wealth. Passing on the lessons learnt from this tumultuous period ensures the next generation is equipped to handle the wealth they inherit.
Vern Gowdie
Editor, Gowdie Family Wealth
From the Archives…
Is This the Spark to Send Australian Property Crashing?
26-07-2013 – Kris Sayce
Why it’s Deflation…Not Inflation, that’s Heading Our Way
25-07-2013 – Vern Gowdie
Why You Must Avoid This Big Investing Mistake…
24-07-2013 – Kris Sayce
The Dark Side of Technology: Part 2
23-07-2013 – Sam Volkering
The Dark Side of Technology: Part 1
22-07-2013 – Sam Volkering