Will the bulls ever learn their lessons?
What lessons should we be learning? What am I even talking about?
gideon made an interesting comment on my last post and my response basically turned into a post. I have some ideas on lessons. Here is part of the comment:
[I] am finding the whole big X wave count to be nihilistic, and depressing. I cannot get over how 11 years into this bear there have been ZERO lessons learned. NO decrease in leverage or risk, no criminal charges, no budget cuts, no reduction in PEs or increase in Div yields.
gideon is referring to the large Cycle Degree X wave that I have been proposing, here are some references: Macro Thoughts and Observations. Is the Bear Market Dead? Is this the Start of a new Secular Bull Market? and here: Bear Market Momentum Internals: Examination of Moving Average 'Price Stretching'
But to the real point of this post: 'What are the important lessons that the market keeps telling us and we keep forgetting?'
.... Mean reversion and overshoots.
It always happens. The markets are cyclical. There are all kinds of cycles. But the long ones that govern what we call 'secular trends' have been around for a long time.
John Mauldin's recent post talked about this very issue: http://www.johnmauldin.com/outsidethebox/a-sideways-view-of-the-world. Secular trends, cycles, and mean reversion is a theme in a number of my macro posts.
The problem is that the market never gets there all at once. Even within secular cycles, there are oscillations (cyclical bull and bear markets). And anyone who gets too ideological on the secular trend will get blindsided when a cyclical countertrend emerges.
And I am 100% speaking of myself. I fully admit I have allowed my bearish bias from playing this cyclical bull market correctly. There was a significant amount of honest-to-goodness bullish macro and fundamental developments (the stuff that any bull market is built on top of) that I was discounting because I believed it was in the 'noise' compared to the bearish macro.
I was wrong. I am not afraid to admit that. As an analyst I have to understand my mistakes and why they happened.
The 2007-2009 crisis was a powerful cyclical bear market within the secular bear. But cyclical bears always give way to cyclical bulls, and vice versa. Nothing ever goes up or down in a straight line, and when one trend gets established and people 'know' it will either continue or resume after a brief pause ... it changes.
And it's just human nature. I talked about this phenomenon before (see here: http://caps.fool.com/Blogs/what-g20-will-not-discuss-this/410156#comment410272). Humans want to linearize and extrapolate trends. But the truth is, they are just not very common. The world is built on cycles, and not surprisingly, our stock market also exhibits cycles. Humans on average are pretty bad at seeing and understanding cycles, especially if they last longer than a year.
Further, in the stock market, we know from history that bull markets are always slower and take longer than bear markets. From a 10 year chart to a 10 minute chart, we always see trends that take a long time to build up to the upside and then get erased to the downside in a fraction of the time.
Think about it even from recent history
1995-2000: Bull Market (5 years)
2000-2002: Bear Market (2 years)
2002-2007: Bull Market (5 years)
2007-2009: Bear Market (2 years)
2009-20xx: Bull Market
Why are we expecting this bull market to be so much shorter? Why are we expecting this time that it will be different?
Maybe this time it will be different. But when I step back, and I clear my head of biases, and I read the cyclical lessons that the market teaches us and I think about the ebb and flow of trends, the logical conclusion is: 'this time it *won't* be different'.
This bull market will continue. It will take it's time and eventually slow down. It will crush bears. And at the top, everyone will be a bull, and extrapolating a new secular bullish trend, even though we know from history that this secular bear market is likely not done.
Cyclical markets have to run their course.
So this brings me to gideon's comment. I do think that corporations are healthier now than they were 2 years ago. And I expect them to be relatively healthy during the next cyclical bear market (the one that I believe will end this secular bear) sometime in the next 5-8 years. The difference will be that P/E's will compress. They will go to single digits, just like they have done in every single secular bear market that we have records for.
That will be when we find the real values. Not here with the SPX over 1300. The 2009-20xx bull market's purpose was to get rid of much of the unhealthiness that got trashed from 2007-2009. Corporations are by and large doing much better, and the next cyclical bear will be about margin and P/E compression. There will be a lot of babies thrown out with the bathwater.
In the same vein, because corporations will largely be healthy during the next cyclical bear, I expect many of them to use their balance sheets to pay out dividends in higher rates than we have seen in the last many years. The markets will be crushing stock prices, and to return shareholder value the companies will increase payouts. In fact I expect very good yields before this secular bear is done. (see here, the signal of major secular ends will be when the Div Yield on the S&P approaches the P/E).
There are many lessons that I am sure we as market participants and as a nation won't learn, but I think the purpose of this secular bear will be to remind us of many of the ones we have forgotten.
So until then, it is best to not be either a permabear or a permabull, but rather a permafrog. Mean reversion is a powerful thing (which the permabulls don't understand). As are cyclical deviations away from a secular trend (which the permabears don't understand). As biased as I have been in the past, I am interested in letting the larger cycles unfold as they want to, as history has shown us that they are likely to do, rather than trying to impose my view on the markets. I will try to ride the large trends and hop on to the next when it is ready to turn, and not try to anticipate too much ..... ribbit :)