Growing Evidence that the Secular Trend in Equity Prices May be Reversing

A byproduct of the record monetary and fiscal stimulation that took place between 2020 and 2021 has been rampant speculation in financial markets. That frothy behavior has extended from housing through to technology stocks, SPACS, NFTs and of course crypto. Since equity prices started dropping in January though, we have continued to hold the belief that the secular bull market dating from 2009 is intact and that a further up leg is possible. We therefore made the assumption that the current bear is a counter-cyclical correction in an on-going secular uptrend, rather than a pro-trend primary bear under the context of a secular bear market. The distinction is incredibly important because primary trend bear markets that develop under the context of a secular bull are almost invariably contained in either magnitude (15 - 25%), duration of 6 to 9 months, or both. This compares to the typical 40 - 60% and 15- to 24-month loss when the secular movement is bearish. At Pring Turner, we call the former “burglars”, because they have the effect of temporarily hurting portfolios. The latter are named “bank robbers” because their effect is far more pervading. The current primary bear market at -20% has yet to exceed the burglar range in either magnitude or duration. However, some of our indicators monitoring secular trends have either moved into the bearish camp or are right at its doorstep. Complicating matters is the fact that many intermediate term indicators are calling for a summer rally. If the secular bull is still alive, and when some very long-term indicators are at crucial must hold levels, it seems as good a time as any for expecting the resuscitation of equities. Bottom line: if a new secular bear is underway, we may not find out this side of the fall.

Secular Trends and Inflation/Deflation Excesses

All secular bear markets are characterized with a long-term (10- to 20-year) decline in inflation adjusted stocks. These pervasive negative trends are almost always caused by elevated price inflation, but parts can also be characterized by excessive deflation, as in 1921, 1929 - 1932 and more recently the late 2008 / early 2009 part of the financial crisis.  These unusual swings in inflationary and deflationary forces reflect longer-term structural problems, which is why secular price movements typically extend between 10 to 25 years. This point can be appreciated by observing the plethora of recessions that develop during the (shaded) secular bearish periods in Chart A1 and their paucity post 1900 in the unshaded secular bulls. Even those recessions that develop under the context of a secular bull are generally mild; 1960 and 1990, or brief, as in 2020. Because of the length of these very long-term price movements, it’s usually only possible to spot reversals several years after the final turning point. Citing a reversal within 5 months of a possible (January 2022) high with any degree of certainty, is therefore pushing the envelope somewhat.

Secular Price Movements from an Historical Perspective

Chart A1 isolates secular trends since the middle of the nineteenth century. The thick vertical lines flag the six previous secular peaks in inflation adjusted U.S. equities, the shaded areas are their subsequent negative trajectory. While every price high can be identified this way, not every oscillator peak has been associated with an equity secular bear. The late 1870s and early 1880s come to mind. May saw this indicator flatten, but the oscillator, which is calculated by dividing a 60-month by a 360-month EMA, is still rising. It’s also important to note that it’s currently trading at a level only seen once before; at the tail end of the first tech boom. Moving even higher from here will require a monumental dose of upside momentum at a time when the latest data from several secular indicators has begun to move in the opposite direction. Secular stock movements are closely tied to inflationary and deflationary swings.

In that respect Chart A2 compares inflation adjusted equities to a very long-term price oscillator for industrial commodities. In order to correspond with equity market fluctuations, the oscillator has been plotted inversely. Consequently, when this momentum series is rising, it reflects a decline in inflationary pressures, which is generally bullish for equities. The red highlights tell us when a negative secular environment is being signaled by the oscillator. That occurs when it trades below its 48-month MA. This approach does not pick up deflationary bear markets, which is why the 1929-32  and 2000-2002 sell-offs were not signaled. On the other hand, every time a sell signal is triggered, a bear move usually follows or is already underway. Flaws include the fact that it was early in its 2005 warning and the 1990 signal turned out to be a whipsaw. However, that’s the only one in 120 years of history. The indicator was also unduly late in signaling the all-clear in 1949 and 2009. Earlier this year, a sell signal was triggered, pushing this approach into the secular bearish camp for equites and a bullish one for industrial commodities. The ratio between stocks and commodities is another useful relationship that we can follow. When in a rising mode, it indicates that stocks are not concerned by what is happening in the commodity pits. From a primary trend aspect though, downside reversals in this relationship suggest rising commodities are beginning to adversely affect profits and is a sign of a weakening bull market, or worse, for stocks.

This relationship also holds for secular trends as we can see from the long-term price oscillator in the bottom window of Chart A-3. Once again, it’s evident that every secular peak has been signaled by the oscillator, but not every oscillator peak is a secular one. It recently dropped below its MA and has most probably peaked for the current primary trend cycle. On occasion, the oscillator has also lent itself to trendline construction. Indeed, it has been possible to construct up trendlines for the three previous secular bulls. Their violation confirmed that a peak had taken place. The oscillator is currently right at a fourth up trendline. The next couple of months will likely decide whether it’s violated or if a third post 2010 oscillator rally will materialize.

One important characteristic of a secular bear occurs when the CPI exceeds 7.5-% on a year-over-year basis (Chart A-4). This has happened ten times since 1900. On each occasion, with the notable exception in 1951, inflation adjusted equities were in a secular bear. These instances have been flagged with the vertical red lines. This observation underscores the fact that secular bears are caused by structural, as opposed to cyclical, imbalances. One reason is that inflation hits lower income classes the worst. Unfortunately, they have a very elastic demand curve and consequently find it very difficult to adjust to rapidly rising prices. It’s worth noting that the 1951 example was preceded in 1950 by a high of +6.5% in the 18-month ROC for inflation adjusted M2.  Compare that to 2021, when the ROC topped out at a  post 1945 record of +25%. Finally, it’s worth remembering that the 1951 situation developed at the beginning of a secular equity bull (1949-1965/6), whereas many indicators are suggesting that after 13 years, we are currently closer to the end of one.

Stocks versus M2

One of our favorite long-term relationships is the ratio between stocks and money supply (M2). When rising it means that stock market participants are expecting fresh injections of liquidity to favorably affect the economy and corporate profits.  A falling relationship on the other hand, implies that market participants suspect that insufficient liquidity is being pumped into the system, resulting in a growth slowdown or even an actual business contraction. The ratio is helpful from both a secular and primary trend aspect. Chart A-5, for instance, shows that it tracks secular price movements in inflation adjusted stocks quite closely. One technique for isolating the status of the secular trend is to observe when the ratio crosses above or below its displaced 96-month MA. Periods when this relationship is below its MA have been identified with pink shadings. Note there are very few whipsaws during the chart’s 120-year history, so a crossover usually remains in force for many years. The latest plot tells us that the ratio is barely above its MA. The vertical lines mark oscillator peaks, two of which was followed by a secular bear of some kind. The indicator is currently positioned in a bullish mode above its 24-month SMA. However, it has started to go flat, which could be prelude to a downside reversal. This relationship clearly demands close monitoring going forward for a possible secular sell signal.

Chart A-6 takes this a step further by focusing on the post 2000 period. There are a couple of points to make. First, the ratio experienced a probable false upside break from a massive accumulation pattern. The break is extremely close to being confirmed, which would happen with a decisive drop below the 20092022 up trendline and displaced 96-month MA. Since the long-term KST is in a bearish mode, the odds of a downside break are enhanced. Equally as important, the deflated S&P is just a whisker above its 2009-2022 secular up trendline.

The Shiller PE

The Shiller PE attempts to smooth out cyclical fluctuations by calculating real corporate earnings over a 10-year period. Most observers interpret it as a measure of valuation, but we think of it more as one of sentiment, reflecting as it does, gigantic swings in psychology typical of secular price movements. These swings can be roughly followed by observing the ratio in conjunction with its 96-month MA. Positive periods appear as green highlights in Chart A-7, bearish ones in red. At the end of May, the PE was straddling its 20102022 up trendline and the MA. If it drops much below them, it will confirm beyond a reasonable doubt that the 2021 upside breakout was an exhaustion move, in effect, placing this indicator in the secular bearish camp. The recent flattening action from the price oscillator, shows that it could be poised to go negative as well.

Comparing the PE to the yield on the government bond yield offers some long-term perspective on the current return between stocks and bonds.

Chart A-8 shows that a downside reversal in this relationship has flagged numerous cyclical sell signals, some of which have been flagged with the small arrows. Worse still, the ratio itself has dropped decisively below its post financial crisis up trendline and its 96-month MA. We can see that the ratio itself has violated its 2009-2022 up trendline and crossed below its 96-month MA. Arguably more important is the fact that the price oscillator has dropped below its overstretched zone for the third time since 1929. Both previous reversals accurately signaled the end of their respective secular bull markets.

Conclusion

We can’t be sure that the equity secular bull market is over, but it’s quite apparent that the indicators are currently moving in that direction. Many others are on the brink of a sell signal. The inflation adjusted S&P has reached support in the form of its secular up trendline (Chart A6) and several intermediate indicators are in place to support a summer rally and therefore the avoidance of further deterioration. That said, there are enough secular style bearish omens to indicate the necessity of taking a cautious stance until the evidence starts to move in a more positive direction.