21 Oct, 2004
extracts from a commentary posted at www.speculative-investor.com
on 17th October 2004.
The US Stock Market's
The secular trend in the stock market should be defined in terms
of valuation rather than price. This is because it would, for
example, be possible for the Dow Industrials Index to move higher
during a secular bear trend if inflation caused a sufficiently-large
reduction in the purchasing power of the US dollar. In such a
case the Dow could trend higher in nominal dollar terms due to
the boost to earnings and asset prices provided by a weakening
dollar, but the average price/earnings ratio of the market would
contract as would the real (inflation-adjusted) level of the
Further to the above, we think the best way to define the secular
trend of the US stock market is in terms of the Dow/gold (or
S&P500/gold) ratio because any long-term boost to the nominal
level of the Dow from a weakening dollar would be offset by a
rise in the gold price. Specifically, we consider a secular bull
market to be a very long-term (10-25 year) upward trend in the
Dow/gold ratio and a secular bear market to be a downward trend
in the Dow/gold ratio lasting 10-25 years (*). The following monthly chart shows how these
trends have played out over the past 75 years.
In our opinion
the US stock market is presently about 5 years into a secular
bear trend that should, if it follows the path of the previous
two secular bears, take the Dow/gold ratio down to the bottom
of the channel drawn on the above chart. This, in turn, would
result in a Dow/gold ratio of around 5 assuming the bottom is
reached within the coming 10 years.
Now, towards the end of the 1966-1982 secular bear market the
Dow/gold ratio spiked well below the channel bottom, but this
was due to the upside blow-off in the gold price during 1979-1980.
Regardless of the cause of this downward spike, though, long-term
investors who bought into the stock market when Dow/gold hit
its channel bottom in 1974, who continued to buy all the dips
in the stock market as long as Dow/gold remained within the bottom
30% of its channel and who then began scaling out during the
rallies after Dow/gold moved into the top 20% of its channel,
would have done extremely well (they would have achieved substantial
REAL returns). On the other hand, long-term investors who purchase
'the market' with the Dow/gold ratio near current levels are
almost guaranteed to achieve very poor REAL returns over the
coming 10 years.
*It would also be appropriate
to define the secular trend in terms of the market's price/earnings
(P/E) ratio with a long-term upward trend in the P/E ratio being
the hallmark of a secular bull market and a long-term downward
trend in the P/E ratio being the dominant characteristic of a
secular bear market. However, we prefer to use Dow/gold because
the gold price is a known quantity whereas the "E"
in the P/E ratio is an accounting estimate and is therefore open
Gold: the big picture
During a secular
gold bull market gold moves higher in terms of all major fiat
currencies due to declining confidence in government and financial
assets throughout the world. In this important respect the 1999-2004
rally in the gold price has the characteristics of a secular
To help illustrate the above point we've included, below, a long-term
chart of the gold price in terms of the Swiss Franc. The Swiss
Franc has been one of the world's strongest currencies over the
past 34 years, so for the purpose of this discussion it is a
good currency to use (when gold is trending higher in terms of
the strongest currencies it will, of course, also be trending
higher in terms of the weakest currencies). The chart shows that:
a) Gold has trended higher in SF terms over the past 5 years.
b) Gold did NOT trend higher in SF terms during 1985-1987, indicating
that the 1985-1987 gold rally was a cyclical bull market within
a secular bear market (it was a counter-trend move).
c) Gold trended higher in SF terms throughout the 1970s.
to the above chart it is interesting to note that the slope of
the upward trend over the past 5 years is almost identical to
the slope of the upward trend during the 1970s. However, what
we haven't yet seen during the current bull market is a period
when the gold price accelerates up and away from the long-term
trend-line, whereas during the 1970s there were two such periods
(shown in red boxes on the chart).
Although the first half of this year was a likely TIME for an
important peak in the gold price, the complete absence of trend
acceleration up until now suggests to us that we haven't yet
reached the point where a major downturn is probable. Instead,
we think there will be a very sharp rally in the gold price in
terms of all currencies -- either over the coming two months
or during 2005 -- before a major correction gets underway.
21 Oct, 2004
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