Morgan Stanley analyst Teun Draaisma outlines eight lessons (Only four of which are interesting) to live by in this bear market over at the FT’s Alphaville Blog. And make no mistake about, says Draaisma, this is a bear market. In his first “lesson” Draaisma cites the Shiller PE, a cyclically-adjusted price multiple, to demonstrate that stocks are still very overvalued:
The cyclically-adjusted PE, aka the Shiller PE, represented by the latest price divided by the average earnings of the last 10 years, reaches 10 or even less at bear market bottoms… These valuations are the biggest problem with today’s market, as the Shiller PE is more than twice that. Today’s message: Shiller PE is above 20 still, while true bear markets tend to end at less than 10 times (see Exhibits 12 and 13). Equities are not cheap enough and need to decline by at least 50 per cent.
Draaisma’s second point is that Bear Markets tend to last a long time, and we might have a few more years to go before we get out of our current funk:
The average duration of bear markets has been 14 years, with the much more rapid 1929-32 episode, when equities went down 89%, the exception. Today’s message: we are in year 8 of a 14 year bear market.
Draaisma’s third lesson to live by is that the popular conception that “there are no bulls left at the bottom” is a myth. In reality, the final slump usually trails off on lower and lower volumes:
The popular myth that there are no bulls left at the bottom of the bear market is wrong. Many market commentators are correctly bullish right at the bottom of the bear market. Popular myth has it that talk of ‘equities are dead’ and ‘there is no future for equities’ should be widespread and are classic signals of the end of the bear market… Today’s message: do not take any ‘contrarian comfort’ from the fact that many people are quite bearish on the macro outlook, contrary to conventional wisdom, that is not a classical sign of a bear market trough.
Draaisma’s fourth point (and the last we’ll detail here) is that the lead time between recoveries in equity markets and real economic recoveries is usually shorter than 6-9 months:
Equities do trough during economic recessions, but they do not anticipate economic recovery by 6-9 months. The lead time is much shorter, and often equity and economic recoveries are coincident, and sometimes economies bottom before equities do so. Patience is key. Today’s message: indeed, this is consistent with our finding that one should be patient in bear markets as there is not much discounting of the upturn going on at the end of the bear market, after numerous failed rallies and false hopes
So, if you buy Draaisma’s bear thesis, stay patient, and only start to buy as economic indicators begin to show a robust and sustainable economic turnaround.