Bull/Bear Debate Part 1

Special Note: As part of a two series bull/bear debate today’s newsletter gives the most bullish possible spin on the current state of the three categories we track every day. Next Sunday I will give the bearish counterarguments.

Charts: At the end December 2008 the market had dropped only 38%, a harsh but not historically bad bear market. In 2009 from January to March the market kept plunging until it bottomed with nearly a 60% loss, a bear market of historic proportions. The 2009 plunge was due to the view that TARP wouldn’t work, against all odds TARP did work; banks are indeed bailed out and profitable again. Therefore the sharp downward spike in early 2009 doesn’t count. Erase the spike and draw a straight line across it and we had about a 40% down bear market followed by a stout but not freakish 24% gain, in line with the first year of most Great Moderation Era (GME) bull markets. P/E ratios are only slightly elevated for a GME bull, but multiples are extremely elevated if we are no longer in the GME and are still part of the 100-year average. For the last two months the market has moved sideways, this action allows multiples to catch up to stock gains. This is bullish action only if we are still in the Great Moderation Era.

Fundamentals: Academia says that the GME is due to superior Federal Reserve policy from 1982 and continuing today. We now know that Greenspan’s policies sucked. Bernanke is better but he’s made some mistakes. Of the 3 GME Fed Chairmen only Volker was truly superior and he was top dog for just 1/6 of the GME. Furthermore, Fed policy in the 50s and 60s produced lower and more stable inflation than during the GME as well as more stable growth, better overall policy. All the 50s and 60s Fed Chairmen were as good as Volker. Multiples stayed within the depressed 100-year average in the 50s and 60s. Only in the GME have they been permanently elevated. It obviously isn’t because of superior Fed policy.

Geopolitics: The real reason for the high GME multiple is geopolitical. From 1870 until 1982 the world order of a single Anglo-Saxon superpower (Britain then America) was continually threatened by a continental superpower (Germany then Soviet Russia) and over that time period the instability of two rival superpowers on one planet caused low multiples. The lowest multiples ever recorded were during the period where there was no Anglo-Saxon superpower, i.e. when dominance of the English-speaking world was being handed over from Britain to America in the 1930s. In 1933 stock market multiples hit the lowest level in history. This is the year that Hitler became Chancellor of Germany and at that point there was only one superpower: Germany. The next 6 years and most of WW II saw a world dominated by a single continental superpower; it marked the greatest departure ever in the industrial age from the market-friendly model of a single Anglo-Saxon superpower. The decade of a single German superpower generated the lowest multiples of any decade in history.
From 1815 until 1870 there was a single and uncontested Anglo-Saxon superpower after Britain destroyed that other continental superpower, Napoleon’s France. Records are spotty but I believe that 55-year stretch starting in 1815 produced GME-like elevated multiples. That stretch of unrivaled British superpower status carried a high P/E ratio that is relevant to today’s market, not the lower multiple from the 112-year stretch of bifurcated superpower status. With the Long War going well the world is clearly back in the grip of a mono-polar Anglo-Saxon geopolitical order and multiples over 18 for the S&P 500.