If you want to know where the stock market is headed, ignore the pundits. Look instead at the back of an American one-dollar bill.
There, on the left side of the Great Seal of the United States, below the pyramid topped with an eye, is a banner with the phrase novus ordo seclorum – "new order of the ages."
One meaning of the term "secular" comes from the Latin word that means era, age, or extended period. Charles Thomson, a Founding Father and principal designer of the Great Seal, described the meaning of the phrase as "the beginning of the new American Era."
When the word "secular" is applied to stock market cycles, it denotes an extended period with something in common throughout. Secular bull markets are long periods that cumulatively deliver above-average returns. Secular bear markets are the opposite. They bring cumulative below-average returns.
Knowing which secular cycle we're in will tell you a lot about the future direction of Wall Street.
Recent market gains have many traders and analysts buzzing about the start of a new secular bull market. The economy is recovering. Profit margins are fat. The most common measure of stock market potential – the price-to-earnings ratio or P/E – is flashing green. So, after more than a decade of market losses, have we reached the turning point?
Unfortunately, the signs are as deceptive as a warm November day.
Take those fat profit margins. They're near record highs. Now, unless you believe that the stock market fairy has somehow suspended the past 100 years of American corporate history, those profits – earnings – are unsustainably high and will most likely fall within the next few years.
When they do, those bullish P/E ratios will stop looking so wonderfully green and start flashing a cautionary yellow.
Today's P/E, based upon more normal long-term profit margins, is actually fairly high by historical standards. Although the past decade worked off the excesses of the 1990s bubble, it has not driven the stock market to levels that are needed to start another secular bull market.
That's not me talking. It's the mathematical record of more than a century of stock market returns. A high market P/E, with its low dividend yields and risk of decline, produces below-average returns. A low market P/E drives above-average returns. The market hasn't fallen enough yet.
Investors need not fret. Secular bear market periods still provide opportunities for solid returns. But to achieve them, investors have to work harder, diversify more, and manage risk.
To use a sailor's analogy, when the wind is no longer behind you, you have to row. There are many ways to "row" portfolios. Investors can focus on higher dividend-paying stocks and keep a sharp lookout for better values. Other investments, which often provide more stable returns, are likely at times to be attractive, such as REITS, master limited partnerships, and private investment offerings. Portfolios can also benefit from securities that hedge against inflation and deflation.
Don't dock your boat just because the next secular bull market has yet to arrive. Drop the sail, pull out an oar, and put yourself in a better position once the secular bull winds begin to blow again.
If history is a guide, that may take another decade or longer.
– Ed Easterling, head of Crestmont Research, is author of the new book "Probable Outcomes."