Equities have historically experienced secular bull markets characterized by rising valuations, as measured by the ratio of share price to trend earnings or P/E, interspersed by secular bear markets characterized by falling P/Es. Post war secular bull markets occurred in the 1950s and 60s, driven by declining business cycle risk, and 1980s and 90s driven by declining inflation, interest rates and geopolitical risk. Secular bear markets occurred from the late 1960s to the early 80s with the advent of stagflation and again starting in 2000 following the collapse of the tech bubble, new geopolitical risks and subsequent financial meltdown. Secular bull markets have thus occurred in response to shifts from unfavorable to favorable economic environments, and vice versa*. Moreover, they also always start at extreme P/E lows and end at extreme P/E highs.
Unabated global deflationary forces and unintended consequences from massive central bank intervention suggest a continued high risk economic environment going forward. P/Es may thus not yet have hit the extreme lows that would signal the beginning of a new secular bull market – implying that equities are vulnerable at current levels. (See our previous features – P/E Challenged, Gauging Equities, P/E Extremes, Deflation Dynamics and Equities in Transition).
* Yoav Benari, “Optimal Asset Mix and its Link to Changing Fundamental Factors”, The Journal of Portfolio Management, Winter 1990.
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