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When bull returns, most won't believe it
Saturday, October 05, 2002
Guest columnist Carlyle Dunbar, one of Canada's most respected business journalists, has been writing on the investment industry for 48 years. He is best known as a writer and editor at the Financial Post from 1962 until 1992. He currently writes a column for the Investor's Digest of Canada.
This doesn't feel like the end of a bear market, and the figures support that feeling.
Major bear markets such as the one we're in come along rarely. The current bear market is the worst since 1973-74, and that one was the worst since the great crash of 1929-32. The experience of being through one of these bears helps gauge another.
I recall a 1974 New Yorker cartoon caption saying, "What do you suppose happens when the stock market goes down to zero?" Humour so typically expresses a truth, and in 1974 investors did start to believe the world was coming to an end and the market was headed for zero. We haven't reached that point. There are still too many people out there who believe we've hit bottom.
When the bear market does end, most people won't believe it. That is a clear memory from early 1975, when the market rallied tremendously. I wrote an article -- based mainly on the opinion of U.S. market analyst Richard Russell -- reporting a bull market had started in the United States and Canada. It invoked no reaction from readers that I can recall, and nervousness from editors.
Investors didn't believe in the bull market for years to come, because they had been so badly burned in the long collapse of the 1960s bull market. Though investors like to believe themselves rational, they ultimately act based on emotion.
In 1973-74, there was Watergate, soaring energy prices, auto sales down by one third or more, and the biggest bank collapse in U.S. history (the scam artist responsible had first practised his trade in Canada). Mutual fund redemptions were so severe the Canadian mutual fund organization stopped publishing the data, on the theory that if investors closed their eyes, the bad news would all go away.
Are today's corporate scandals a new factor in this bear? Not really, because every business boom produces scams and crooks. There were Enron-type frauds in the 19th century U.S. and British railway booms, and corporate chief executive officers who ripped off their companies in the 1920s.
Even war does not deflect the market's primary trend, whether bull or bear.
Market cycles are more powerful than any central bank or government, short of closing down the markets. The markets anticipate change in the business cycle. Nothing that Bill Clinton or U.S. Federal Reserve Board chairman Alan Greenspan did in the 1990s could derail the bull market, and nothing George W. Bush or the U.S. Congress or Mr. Greenspan can do will stop this bear market. It will stop when the market anticipates the economic cycle is turning up, and that cycle is almost a force of nature.
The numbers support my belief we are only part way through a major bear market. These numbers are the prices investors are willing to pay for stocks, primarily by the ratio of prices to per-share earnings. These are still exceptionally high. Market valuation ranges from one extreme to the other, from unusually low to unusually high, in swings that take years to complete.
The past bull market illustrates all these points. It endured 18 years, from 1982 to the peak in 2000. As measured by Standard & Poor's 500 composite index, earnings increased 3.7 times in this period. A big move, but stock prices climbed much more, nearly 15 times.
Investors supplied the lever. By the time the bull market ended, they were willing to pay three times more for a dollar of earnings than they had at the beginning. The price/earnings multiple rose from eight times earnings in 1981 and 14 times in 1982 to a peak of 32 times earnings in 2000. The P/E climbed to a peak of 45 early this year. In 1974, the price/earnings multiple dropped below eight, a key indication the bear market was running out.
In the records available, we can see that bull markets generally start when stocks trade at less than 10 times earnings. They end when the P/E multiple rises to 20 or more.
The Canadian experience is parallel, as it always is, because 70 per cent to 80 per cent of what happens in the Canadian market is explained by what the United States does. If you want to know what is going to happen in the Canadian market, look to Wall Street.
Translating the S&P multiples into Canadian terms is difficult because the Canadian market is not nearly as diversified and deep as Wall Street. Entire industries are missing, or represented perhaps by a single investable stock. As a result, earnings and P/Es are more volatile. For example, the S&P/TSX composite index just started showing a price/earnings multiple last month, after 12 months of reporting no earnings. The current S&P/TSX multiple is 66, incredibly high by any standard.
Stock market cycles repeat themselves, because human emotions never change. The talk, the comments, statements from corporate grandees and star analysts in the past couple of years echo what we heard in 1973-74, and again in the 1981-82 bear market.
Each generation learns the lesson of excess all over again. When the idea "this time it's different" swept the market in the late 1990s, it was time to start thinking about getting out. It is never different. When the market is at its peak, almost everybody is bullish. When it hits bottom, almost everybody is a bear.
This judgment may be harsh, because it is sometimes difficult to recognize significant events in the market when they occur; usually they become clear with hindsight. As a new and very inexperienced business reporter, I vaguely recall the day in 1954 when the Dow Jones industrial average closed above its 1929 high for the first time. It did not seem remarkable until a veteran business reporter pointed it out.
The significance sank in gradually: it had taken 25 years for the market to recover from the crash following its greatest bull run. Our 1974-2000 secular bull market became the greatest. It will be a long time until the market recovers.
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