Submitted by Adam Hamilton:
The US stock markets enjoyed an incredible first quarter, with the flagship S&P 500 stock index (SPX) surging 10.0%. New cyclical-bull highs were achieved on an amazing 3/7ths of all Q1’s trading days! But the most interesting one was certainly the last. On Q1’s final trading day, the SPX edged up to a new all-time record high. Though celebrated with great fanfare, adjusted for inflation it was far from a record.
Thanks to central banks rapidly inflating their fiat-money supplies, long-term price comparisons are problematic. As the Fed relentlessly injects new money into the US economy every day, the purchasing power of each dollar slowly erodes away. A dollar today buys less than a dollar did 5 years ago, and the farther back you go the greater the disparity. Considering inflation is essential in any long-term analysis.
Much of my longest-term research has been focused on gold and silver, which peaked in January 1980. But those topping prices ($850 and $48) are meaningless in today’s dollars. Back then the US median household income was under $18k. New houses across the nation averaged just $76k, while new cars generally cost under $6k. With far fewer dollars then, each one had vastly more purchasing power.
Now the stock-market record highs just broken certainly don’t extend back that far, we are talking about one decade as opposed to three. Over a much shorter timeframe, inflation’s impact is much lower. But it still isn’t trivial. The previous SPX record high of 1565.15 was achieved in October 2007, and the 5.5 years since left the Fed lots of time to print money. The growth in its money supplies since is staggering.
Between the week of the SPX’s last record high in October 2007 and late March 2013, the Fed expanded its narrow M1 money supply by 81.8% and its broad MZM by 48.3%! If this doesn’t shock you, you’re not paying attention. There are somewhere between 50% to 80% more dollars floating around in the world now than at that last SPX record high. Such a wildly-ramped supply means each one is worth much less.
You are well aware of this if you support yourself and your family. It costs a lot more to live today than it did in late 2007. Everything we need to live, from food to shelter to energy, is way more expensive. It takes more inflated dollars to buy essentially the same goods and services. For decades I’ve tracked every single dollar I spend with computer software, and the amount of inflation I’ve seen is astounding.
So comparing a nominal (not inflation-adjusted) high from October 2007 with one today isn’t righteous. With much more money in circulation now so each dollar today is worth much less, the straight-up nominal comparison is a flawed apples-to-oranges thing. Only by looking at previous records recast in today’s dollars by adjusting for inflation does an honest comparison emerge. It is truly the real SPX.
In economics “real” means inflation-adjusted. In order to adjust the dominant stock index for inflation, we first have to choose an inflation measure. My preferred one would be the underlying money supplies themselves. Growth there is the foundation of all general-price-level increases. But unfortunately this hardcore approach would be ridiculed by the mainstream. Wall Street lives and dies by the CPI instead.
The US Consumer Price Index is the dominant popular measure of inflation. Once a month the US Department of Labor’s Bureau of Labor Statistics reports this number, which the markets take as gospel. Unfortunately this key metric is heavily manipulated for political reasons, so headline inflation is always lowballed. CPI growth since October 2007 is merely 11.1%, just 1/8th to 1/4th of money-supply growth!
The government actively manipulates the CPI because monetary inflation has such a broad economic and psychological impact. If true inflation was reported, the stock markets would be far lower. Americans would believe the economy was far worse, so politicians would be kicked out of office. Many huge government welfare payments indexed to inflation would soar, along with interest on Treasuries, threatening to sink the whole government.
With high inflation bad for the stock markets, Wall Street is happy to acquiesce to the fiction of the CPI. So while I hate this horribly-flawed inflation metric, I use it in my real studies because it is universally accepted. Since real monetary inflation is now running 7.5% (MZM) to 9.1% (M1) annually compared to the CPI’s laughable lowballed 2.0%, realize using the CPI seriously understates what is really happening.
But here’s the flagship S&P 500 stock index since 2000 in real CPI inflation-adjusted terms. That period covers the last two record highs, October 2007’s and March 2000’s before that. Despite all the super-bullish euphoric hype CNBC has been flogging surrounding the SPX’s new nominal record, the stock markets remain far from a real record. The new nominal record highs are merely a Fed-induced illusion.
The SPX first eclipsed October 9th, 2007’s 1565.15 on March 28th, 2013 with a 1569.19 close. And then again earlier this week on April 2nd, the SPX edged a little higher still to 1570.25. If you follow the financial media, you’d think this was a great achievement. For weeks before the nominal record was slightly broken, CNBC ran a special graphic on its screen showing the distance away from a new high.
Even in ordinary nominal terms, these modest new records weren’t impressive. Over a 5.5-year span since October 2007, the SPX was up 0.3%. This return was colossally bad, lagging far behind even the happy fiction of CPI inflation. And since March 2000, the SPX record high before that, the American stock markets were merely up 2.8% over 13 years! Stocks have been a rotten investment for over a decade.
Why? We have been in a secular bear since that March 2000 peak. Secular bears are long sideways grinds, where long means an average duration of 17 years. You can see the secular-bear trend above in the light-red nominal SPX data. Ever since 2000, all this index has done is consolidate sideways between that peak and half that peak. Call it a giant trading range between SPX 750 and SPX 1500.
The big slides down to half the March 2000 levels are known as cyclical bears, and the subsequent recoveries back up to March 2000 levels are cyclical bulls. A secular bear is a long series of alternating cyclical bears and cyclical bulls. It is at the ends of these cyclical bulls within this secular bear when new nominal SPX highs are seen. But once properly adjusted for inflation, they are far from record real highs.
Even using the flawed CPI, the SPX record high of October 2007 recast into today’s dollars was 1739. Today’s SPX would have to climb another 10.8% higher from its latest record to achieve a real high better than that. But even that would be far from a real record. Back in March 2000 when our dollars were worth much more, the CPI-adjusted SPX peak was 2071 in today’s dollars. That’s 31.9% higher from here!
So all of today’s record-high talk in the financial media is incredibly misleading. In order for stock investors to merely regain their purchasing power at the March 2000 peak that marked the beginning of this secular bear, they’d need to see the SPX rally a third again from its new nominal records. Not accounting for dividends, stock investors have seen a staggering 24.2% real loss over 13 years!
After writing 567 of these weekly essays I have a hard time remembering exactly what I’ve covered, but I think the last time I wrote about inflation-adjusted stock prices was back in August 2005. At that point we were only about 5 years into this 17-year secular bear, so there wasn’t enough time for real secular trends to fully crystalize. So I found the real SPX downtrend in this chart above very provocative and scary.
Secular bears are only 17-year sideways grinds in nominal terms. Once monetary inflation’s relentless erosion of purchasing power is taken into account, the real SPX’s trend is actually down. And this downtrend is pretty steep, as you can see above. By holding on to general stocks that remain flat at best throughout an entire secular bear, stock investors are forced to absorb relatively large real losses.
In early 2013, the real SPX broke out above the real resistance line of its secular downtrend. And this stock-market strength wasn’t due to improving economic fundamentals, but simply a totally unique and unrepeatable fiscal-cliff tax deal. Without that initial early-January surge, which accounted for over a quarter of Q1’s total SPX gains, the momentum would never have been there to edge up to nominal records.
I can’t ever recall hearing of a real breakout deep within a secular stock bear, so I suspect this one isn’t sustainable. This is yet another piece in the overwhelming and damning evidence that our current cyclical stock bull is overdue to roll over into a new cyclical stock bear. This bull move has run for far too long without a countermove to rebalance the increasingly euphoric sentiment dominating markets today.
As of this week, the SPX’s mighty cyclical bull had powered 132.1% higher in 49 months! But the average size and duration of mid-secular-bear cyclical bulls is merely a doubling over 35 months. Our current specimen is too big and too old to last, well past its sell-by date. The SPX is also way above its nominal 1500 resistance, and general complacency has soared to dangerous bull-slaying extremes.
In light of all these major-topping indicators, the real SPX’s situation is even more bearish. The last 17-year secular bear ended in August 1982. And it wasn’t at real highs, but at a major new real low. This last chart extends the real SPX back out to encompass that entire previous secular bear that was born in early 1966. Its secular-bear precedent is certainly an ominous portent for our stock markets today.
Our current secular bear’s real downtrend mirrors the one seen in the 1970s secular bear. Though the SPX ground sideways in nominal terms, actually up 8.9% over 16.5 years, it still lost an astounding 64.3% of purchasing power over that dark span! Meanwhile today’s secular bear is only 13 years old, and the real losses are only 24.2% at this point. Contrary to bulls’ hopes, this secular bear simply isn’t mature yet.
Remember that secular bears are valuation phenomena. They are the second halves of a great third-of-a-century cycle I call Long Valuation Waves. In these waves’ first secular-bull halves, stock markets soar and valuations expand dramatically. The SPX’s P/E ratio mushroomed from 6.6x earnings at the start of the last secular bull in August 1982 to 43.8x at its end in March 2000. That was a bubble, radically overvalued.
The long-term average price-to-earnings ratio of the general stock markets is 14x earnings. The job of the secular bears always following secular bulls is to gradually erase the bubble excesses and return stocks to this 14x fair value. This is accomplished through secular bears’ long sideways grinds. Stock prices drift long enough for underlying corporate profits to grow enough to finally catch up with stock levels.
But just as secular bulls’ valuations overshoot dramatically on the upside, secular bears’ valuations do the same on the downside. Thus secular bears don’t end at 14x fair value, but at half that. Today’s secular bear, like the last one straddling the 1970s, isn’t going to give up its ghost until the SPX trades at 7x earnings. But even during 2008’s crazy once-in-a-century stock panic, the lowest we saw was 11.6x.
If the secular bear since 2000 is over as the bulls desperately claim today, it had to end when the last cyclical bear died in March 2009. But the 11.6x SPX valuation then was 2/3rds higher than the 7.0x necessary to declare a secular bear dead. And if this secular bear wasn’t dead, which it certainly shouldn’t have been merely 9 years into a 17-year event at that point, then our current cyclical bull is overdue to fail.
The real SPX secular downtrend that began in early 2000 hasn’t fully run its course yet. I suspect that will take around 17 years like usual, that’s the long-term average of these great secular moves. The last secular bear ran for 16.5 years before running its course, the secular bull after that lasted 17.6 years, and our current secular bear is only 13.0 years old today. It hasn’t had enough time since its birth to mature.
With the stock markets being far from real records and trapped in a real secular downtrend, this certainly isn’t encouraging for stock investors. But there is no reason to be discouraged. With secular bears lasting 17 years, nearly half of the average investor’s 40-year investing lifespan (between 25 and 65 years old), they last too long to sit out. They simply require a different trading approach than secular bulls.
Secular bears are not easy buy-and-forget opportunities like secular bulls, they require trading. Investors need to buy stocks low as mid-secular-bear cyclical bears end like in March 2009. And then they need to sell high as the subsequent cyclical bulls mature like now. Despite grinding sideways on balance, secular bears present several incredible opportunities for prudent investors to double their money.
During the cyclical-bear years like we last saw from October 2007 to March 2009, alternative investments tend to shine. My favorite is gold, which has earned great fortunes for contrarians during this secular bear where general stocks were flat at best. Gold is a proven performer in all this secular bear’s past cyclical bears, and I expect it will do even better in the next one since this metal is so extremely out of favor today.
And remember that these long-term SPX comparisons exclude dividends, which are an important component of stocks’ total returns. Dividend yields aren’t great during secular bears, since stocks are so incredibly overvalued as the preceding secular bulls end. They’ve ranged from 1% in mid-2000 to 3% at the March 2009 post-panic low. They gradually rise throughout secular bears, getting high near their ends.
If all dividends were reinvested, the real losses in the SPX throughout secular bears would be considerably lessened. They would still exist though, as average dividend yields over a secular bear’s duration are not high enough to outpace even CPI inflation let alone underlying monetary growth. But the real SPX downtrend would still be much more moderate if reinvested dividends were included.
Nevertheless, that doesn’t change the fact the stock markets are in a very dangerous place today. And while a new cyclical bear looms, the financial media has been celebrating a modest nominal SPX high that remains far below a new record in real terms. This illustrates the extreme euphoria pervading the markets today, a very perilous thing. Why mislead investors by hyping SPX 1570 unless euphoria reigns?
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The bottom line is the extensively-hyped new all-time record highs in the stock markets are merely a monetary illusion created by the Fed. In real inflation-adjusted terms, the SPX would have to rally by another third to hit a new purchasing-power record even in lowballed CPI terms. 1570 today certainly doesn’t buy you what 1570 used to, all thanks to the Fed flooding the world with new fiat dollars.
Seeing the financial media’s happy circus surrounding these trivial new nominal SPX records is a definite sign of euphoria. Rational investors not lulled into hyper-complacency or blinded by greed wouldn’t even notice such inconsequential events. The fact that this misleading apples-to-oranges comparison generated so much enthusiasm is just the latest in a long line of major-topping indicators.
Adam Hamilton, CPA
April 5, 2013
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