Email of the day
Comment of the Day

November 20 2013

Commentary by David Fuller

Email of the day

On what causes the big cycles
"I attended you Monday show talk last week and have a query around the secular trends you discuss. This may sound somewhat simplistic; but can you elaborate what causes a long term secular bull or bear market cycle?

"'s premise is that we are at the end of a secular bear and will move before the end of the decade into a new secular bull market. You also highlight the underlying drivers for the secular move; which I understand; and you note the drivers are different for each secular bull run. That's not the issue I have…

"My question relates more to what causes the secular cycles itself. I understand the P/E expansion; contraction idea; but what causes these rolling waves of expansion / contraction every 20-30 years in the stock & bond markets. Since stock markets have begun; we've seen several of these secular moves both up and down, but I am still puzzled as to what cause moves of such duration….

"I attended the Chart seminar in 2009 and I'm well versed in your teachings; but remain unable to explain to myself as to what causes repeating cycles on such duration - as opposed to being easily able to explain to myself in layman's terms; the business cycle, why markets oscillate through cyclical bear and bull phases, and why along the way they experience reactions and corrections; the different types of trending endings you teach...etc..

"I have scanned your entire archives for details around secular bear and bull markets, and while they form a central theme in your long term commentary of late; I can't find any reference discussing what causes the underlying cycle itself.

"If P/E ratios are expanding; investors are paying more and more for future earnings. For whatever reason, when this behaviour suddenly changes and investors realise they have been paying too much; P/Es contract.

"What causes this contraction to drag on for the next 20 years; even though the market can go through a number of four or five year cyclical bulls moves along the way?

"What's causing the majority of market participants to pay less and less for stocks - no matter what's happening; even though we are passing through a number cyclical bull phases… If the world economy can right itself after 5-7 years after a credit crisis, before it get backs to normal GDP growth; why are these cycles taking 20 plus years in the stock market & even longer in the bond market to work through…

"Maybe you could talk us through, what investors are thinking over a complete cycle when these moves are taking place….?

"Why for example can we expect investors to demand higher and higher yields over the next 20-30 years in the bond markets as they market moves into a secular bear…. Apart from stating that every secular bull move is followed by a secular bear move; what's the investor underlying thinking as this secular bull move is unfolding over the 20-30 year cycle....

"Finally Crestmont Research (document attached); whose work you have quoted before; seem to indicate the inflation cycle has a lot to do with investors' expectations and is a key driver behind the P/E secular cycle; yet you don't seem to discuss such a premise that I can find..

"Finally; how much of these secular moves are behavioural; especially as we come to the peak / trough of the P/E expansion contraction cycle; as people know these cycles have taken place before on numerous occasions?

"Your help understanding the underlying investor thinking behind these cycles would be greatly appreciated since it forms such an important premise in your long term forecasting..."

David Fuller's view I enjoyed seeing you and other subscribers on Monday a week ago and thanks for an email of general interest. You have raised a big topic and your analytical curiosity should serve you well. You will also appreciate that one could write a book on this topic but I will try to summarise a few key points.

Secular bull markets are a reoccurring phenomenon, and a good reason not to despair when living through significant bear markets such as 1929, 1974, 1987, 2000 and 2008. In fact, history shows us that significant bear markets provide the best buying opportunities because they compress valuations. Additionally, governments, including central banks, strive to reflate their economies as we are still seeing today.

A secular bull market emerges from a period of deleveraging and valuation contraction. Initially, it is fuelled by monetary stimulus and economic recovery. GDP growth and moderate inflation drive the market upwards. This attracts more investors who bid the market higher. Leverage comes back into fashion. As confidence grows, P/E ratios begin to expand. Secular bull markets are punctuated by corrections and even an occasional cyclical bear market, usually triggered by central bank tightening of monetary policy, before they reflate once more. The latter stages of a secular bull market are characterised by manias, including excessive speculation, a deterioration in corporate governance and reckless bank lending. Supply increases as established corporations undertake secondary offerings in an overvalued market and private companies rush to float their shares. All bubbles eventually burst, usually with the help of tighter monetary policies from central banks.

Secular bull markets are followed by long periods of underperformance, which analysts usually describe as secular bear markets. They certainly include at least one very sharp bear market. However, on long-term price charts they usually look like lengthy trading ranges beneath a glass ceiling, with a few bungee jumps to the downside. GDP growth is notably slower, during a process of corporate and household deleveraging over a number of years. Investors lose interest in stock markets, causing valuations to contract. Inflation and earnings growth enables stock markets to retest their glass ceilings every few years. For this reason I prefer to call these multiyear sideways ranges, such as we have seen for many stock markets since 2000, valuation contraction cycles.

Regarding your question on government bonds, a secular bull market of over 31years for US Treasuries in terms of declining yields ended last year. It was extended by the 2008 crisis and subsequent quantitative easing (QE). Yields can only move up from historic lows as GDP growth slowly improves and QE is curtailed. Yields will certainly increase over the longer term, not least as investors continue to reduce long positions. How much they rise depends on the amount of GDP growth we see, plus inflation and the extent to which central banks raise rates to slow cost of living increases.

Thanks for the informative Crestmont Research document. Although written in 2006, the hypotheses are just as relevant today. I do agree that inflation is partly due to investors' expectations. However, it is primarily driven by money printing in excess of GDP growth and the speed with which that money circulates.

Lastly, behavioural factors such as fear, greed and fashion are extremely important, not least because crowds of emotional people buy and sell a variety of different assets.

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