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Our view on global investment markets:

April 2012 1982


Keith Dicker, CFA
Chief Investment Officer
keithdicker@IceCapAssetManagement.com
www.IceCapAssetManagement.com

April 2012

1982

Jump!
1982 was the best year ever. The crazy disco craze was finally over.
Spielbergs E.T. was hitting the big screens and Van Halen was just 2
years away from learning how to jump.
Yet, the biggest reason for celebration was the end of 16 tortuous
years of stock market losses. Since 1966, investors in the stock
market had lost -10% of their money. Imagine that, a -10% loss from
the stock market over 16 years.
Well, at least these 1970 era investors were not invested during the
1937-41 market. These unfortunate souls lost -38% of their hard
earned savings over a 5 year period.
Better yet, the only good news for these pre-war investors was that
they managed to avoid the 1929-32 market when the luckiest
investors only lost -80% of their money.
These 3 prolonged stock market slumps are forever known as Secular
BEAR Markets. And to be fair, and balanced, the stock market has
also banged out 4 equally opposite periods where investors made
boat loads of money during Secular BULL Markets.
Unknown to many, and ignored by the rest, we are right in the middle
of another long and dragged out Secular Bear Market which has
seen investors lose -7% since the year 2000. Thats 12 years of high
hopes for nothing.

Like every industry, the investment business loves to throw around its
own jargon. For better, or worse the money business seems quite
fond of Bulls and Bears. Bulls or Bullish means prices are rising,
whereas Bears or Bearish means prices are falling.
Chart 1 on the next page provides a great picture of the stock market
from 1900 to 2012 with every Secular BULL and BEAR Market shown.
Youll quickly notice that investors make a lot of money during
Secular BULL Markets, while losing a lot of money or perhaps still
not making any money during Secular BEAR Markets.
Understanding secular markets and how they transition from BULL
to BEAR is perhaps the most rewarding investment perspective you
wont hear from anyone else. While financial markets continue to
yo-yo with our retirements, the truth is, the next Secular BULL
Market is not quite ready to perk its head up just yet.
Day Traders are Pass
Thanks to our enjoyable age of instant communication, one can be
easily forgiven for monitoring financial markets every minute of the
day. In fact it has become so bad that day-traders are now viewed as
long-term investors. Sad, yet true.
Years ago when most current investment professionals entered the
industry, the 3 to 5 year business cycle was talked about now and
then. Since this period seemed like an eternity, one could easily be

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April 2012

1982

Chart 1: Secular Markets 1900 to 2012


1300%

1100%

Practically everyone in the World remembers


the 1982 to 1999 Secular BULL Market and
they extrapolate this experience as the one
that should continue indefinitely.

1214%

900%

774%
700%

500%

317%
300%

100%

-100%

200%

2%

1901 to 1920

1921 to 1928

-80%

1929 to 1932

1933 to 1936

1937 to 1941

-7%

-10%

-38%
1942 to 1965

1966 to 1981

1982 to 1999

2000 to ???

Source: data from www.CrestmontResearch.com, DJIA and S&P 500 Index, graph by IceCap Asset Management Limited
www.IceCapAssetManagement.com

April 2012

1982

Ziggin and Zaggin


forgiven for having glazed eyes when secular markets were
discussed.
Secular markets are usually even longer than the typical 3-5 year
business cycle. In fact, the longest Secular Bear Market was 16 years in
the making from 1966 to 1981. While the longest Secular Bull Market
clocked in at 24 glorious years from 1942 to 1965.
The key point with secular markets is that overall, the stock market
moves in one general direction during a long time period. Now, within
this long-term period, we undoubtedly experience shorter time
periods where the stock market will zig and zag in spectacular fashion.
However, looking through this emotional and financial roller coaster,
the end result is always the same a higher market during a Secular
BULL Market and a lower market during a Secular BEAR Market.
Chart 2 on page 5 shows the 1966 to 1981 Secular Bear Market. Youll
first notice that over this 16 year period, the buy and hold investor lost
-10% of their money. Thats not a happy time.
Yet, within this 16 year period there were 4 mini-periods that gave
investors >+30% returns. Alas, every time investors felt the good old
days were back again, the market produced another 4 mini-periods
that gave investors losses of -25% and more each time.
The lesson unless you are a skilled and nimble trader, beware the
Secular BEAR Market.

Think long-term
When I first started in the investment business, I was told very clearly
that stocks never lose money over the long-run. Long-term investors
are always rewarded for their patience if they just hung in there they
would never lose money. Considering this sage advice was proclaimed
in the 1990s, hindsight makes it easy to see how Secular BULL Market
fever had gripped the industry.
Unfortunately today, most investors and investment professionals
have ever only experienced the Secular BULL Market of 1982 to 1999.
Those were fun times for sure after all, everyone made money.
As they say you always leave a party when the party is going good.
Well, the stock market good stopped going just as the millennium
kicked in. Unknown to many at the time, the newest Secular BEAR
Market had started and continues today into the year 2012.
What causes a Secular Market
There are 3 key drivers of stock market returns profits, dividends and
Price-to-Earnings Ratios (PE Ratio). While profits and dividends are
important, nothing moves the stock market more than the PE ratio.
We ask that you stay with us as we offer our explanation of a PE ratio.
In the magical World of investments, the PE ratio is simply the price of
a stock divided by the amount of earnings per share for the company.
As an example, if IBM is trading at $200 and is making $13 per share in
earnings, its PE ratio is $200/$13 = 15x.

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April 2012

1982

Chart 2: Secular BEAR Market from the 1966 to 1981

-10%

total return
over 16 years

Copyright 2012, www.CrestmontResearch.com

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April 2012

1982

The magic # is 10
As a comparison, Apple trading at $620 with earnings of $35 per share
has a PE ratio = 18x.
This means investors are willing to pay $15 for every $1 of profit from
IBM, while they are willing to pay $18 for every $1 of profit from
Apple. All else being equal Apples higher PE ratio means investors
will pay more for $1 of profit from Apple compared to $1 of profit
from IBM.

eventually end, so do Secular BULL Markets. Years later when this end
arrives, the PE ratio peaks which sets the stage for the beginning of a
Secular BEAR Market. The table below details every SECULAR market
and notes the PE ratio at the beginning and end of each one.

As we rise above the trees of individual stocks and look at the forest,
youll be delighted to know that there is also a PE ratio for the entire
stock market. Based upon the calculation method developed by Yales
Robert Shillers, todays PE ratio for US stocks is = 23x.
The most important point to remember about PE ratios is that in
general the stock market is considered cheaper when the PE ratio is
low versus high. With a PE ratio today = 23x, cheap isnt exactly the
best word to use when describing the stock market.
Next we will share with you something your current advisor is likely
reading themselves for the very first time - how the PE ratio makes and
breaks Secular Markets.
The Beginning of the End
Every Secular BULL Market begins with a PE ratio of 10x or lower. Then
as the life of the Secular BULL Market grows, the PE ratio begins to
climb, propelling the stock market higher and higher. As all good things

Copyright 2012, www.CrestmontResearch.com

Secular BEAR Markets are notable for the long and gradual decline of
the PE ratio which drags stocks lower and lower, until the PE ratio once
again hits 10x or less.
In the year 2000, the stock markets PE ratio was 42x. Today, the PE
ratio sits at 23x and remains quite a way off from the level necessary
to launch another booming period to make lots of money.
If this sounds pretty simple, its because it is. All we need to know now
is what causes this PE ratio to change.
www.IceCapAssetManagement.com

April 2012

1982

Price Stability
The Change
While many analysts, economists and strategists will tell you a million
things that will cause the PE ratio to change, there is no denying that
the #1 change agent is inflation.
Inflation measures the change in prices of all the stuff we buy. The
stock market is a good place to be when the change in prices is pretty
stable at about 1% per year. We like to refer to this as price stability.
Chart 3 on page 8 shows what happens to the PE ratio in relation to
changes in inflation. What youll see is that the real fun for the stock
market begins when inflation begins to move back towards 1%.
Regardless if inflation is 8% or 0%, when it begins to move back to
1%, PE ratios begin to rise which in turn sling shots the stock market
along with it.
Now the opposite also happens. When inflation is close to 1% and
begins to move away from this level, PE ratios begin the dreaded
decline from high to low.
Today, reported inflation is pretty close to the price stability level of
1%. Its quite obvious to anyone who is following the global debt crisis
that the central banks of America, Japan, Britain and the Euro-zone are
all printing money. In general if you print money, super charged
inflation is sure to follow.

At the same time, we are also experiencing a collapse of property


markets in America, Japan, Britain and the Euro-zone. The bursting of
these property markets is hugely deflationary.
Regardless, if investors believe inflation will skyrocket or plummet it is
very unlikely that inflation will remain at the 1% or price stability level.
And, since PE ratios always decline whenever inflation moves away
from price stability the stock market will remain in this Secular BEAR
Market. Expecting the stock market to continue to zoom higher while
the PE ratio is declining is the same as trying to swim while wearing
concrete boots.
As a result, we ask when will the Secular BEAR Market end?
The answer is pretty easy actually, the market needs to reach a PE
ratio of about 10x or less. Now back in 2009, the market was well on
its way to naturally achieving this. However, once the money printing
machines kicked in and various governments refused to let the big
banks collapse, the market was unable to reach its natural state of
equilibrium.
Since the central banks and governments cannot indefinitely delay this
adjustment, we return to our question at what level will the stock
market return to a PE = 10x.
For the stock market to reach this valuation level, only 2 scenarios

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April 2012

1982

Chart 3: How PE ratios are affected by inflation

High Inflation from money printing will


result in a very low PE ratio

Deflation from bursting of global property


bubble will result in a very low PE ratio
Copyright 2012, www.CrestmontResearch.com
www.IceCapAssetManagement.com

April 2012

1982

Careful where you park your car


exist: 1) the stock market would have to decline by about 50% from
current levels, or 2) the stock market will stay flat while we wait for
earnings to double from current levels, which could take 7 to 10 years.

regular basis, the Italians have only begun their long arduous road to
the higher taxes, lower pay and fewer jobs. We suggest all Italians
begin to learn to park their cars in safer neighborhoods.

While this analysis is quite likely unbearable for the investment


departments at the big banks, we take comfort in knowing that once
the market does recalibrate at a PE ratio = 10X, the next Secular BULL
Market will begin. And, everyone who has their wealth in tact at this
point will make a bucket load of money as the good old days return.

Meanwhile, the Spanish are also gearing up for their soon to be


regular protests. Whereas Greek and Italian politicians are doing
exactly as they are told by Brussels; Spanish political leaders are still
Spanish elected leaders and they have rather colorfully told Brussels
to go fly a kite. Spain can handle their growing debts and deficits on
their own, they dont need anyones help. Exactly what Spain is
thinking we do not know. Theyll learn.

Obviously, the trick is to ensure you have your wealth in tact when this
day comes. IceCap is very comfortable with our long-term view and
are managing client portfolios accordingly.
We are equally sure the big box banks have also adopted similar
strategies for their clients and this will undoubtedly allow everyone to
stay rich and become richer at this key turning point in the future.
Good days lie ahead for us all.
Public Gatherings in Protestation
First we had thousands occupying Syntagma Square in Athens. A few
molotov cocktails and overturned cars later, the Greeks certainly made
their point of under appreciation for their unelected political leaders.
Next up, we watched as again, thousands poured into Romes Piazza
dei Santi Apostoli to protest their displeasure with their unelected
political leaders. Whereas Greece continues to hit rock bottom on a

As Brussels did to Italy and Greece, soon enough Spain too will have to
decide whether to accept bailouts from the EU or the alternative of
paying exorbitant interest rates on new debt. Should Spain choose the
bailout route, and they will, they should also be prepared for their very
own unelected-former-Goldman-Sachs-leader.
Now, if global growth picks up, interest rates stay very low, and the
housing market recovers sharply, the Spanish and Italians wont have
to worry about their cars being overturned. We do hope this happens,
yet we remain highly skeptical at this point.
Dont Panic
For those who havent figured it out yet, the daily ups and downs in
the market are certainly not attributed to faster or slower growth and
profits. As it becomes even less obvious to the everyday investor,

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April 2012

1982

Some Point
todays markets continue to move at the whim of anything said by the
central banks.

the entire concept of free markets is dissolving more and more as it


assimilates into a centrally planned state.

As long as the American Federal Reserve or the European Central Bank


indicate they will continue with money printing strategies, markets go
up. Of course, any hint of a sudden halt to this madness and financial
markets go south as investors head for the hills.

It is very well known today that private companies have billions of cash
burning a hole in their pockets. This is certainly reason to be BULLISH
on the stock market after all, they have to spend this cash at some
point. However, as long as free markets move closer and closer to a
centrally planned state some point will never arrive.

Currently, it appears more and more likely that these central banks will
take a holiday (albeit brief) from money printing. And right on cue,
markets around the World have begun to sell-off. European markets
are certainly taking it on the chin the Italian market itself has fallen
over -15%.
Meanwhile, if you are watching American television youd think the
World is coming to an end. This apocalyptic tone is certainly
warranted, after all American stocks have fallen -3%. Yes, today a -3%
market decline is enough to create panic in the streets and more
importantly cause grown Wall Street professionals to actually beg
the American Federal Reserve to print money once again.
Considering this embarrassing behavior from Americas investment
elite, we can only remind people that the stock market can go down as
well as up. And, if a mere -3% move is enough to get peoples dander
up, what will happen if markets fall -20%?
As markets become more and more dependent upon central banks,

Companies will continue to spend the minimum amount necessary to


maintain their businesses but nothing more until they know their
capital investments will not be affected by random and chaotic
monetary and fiscal policies. As central banks continue to bail out
banks and countries, they implicitly create an investment culture
whereby failure is rewarded and success is taxed to reward those
who failed.
Spain
What can IceCap say that hasnt already been said? Not much really.
Financial conditions in Spain are deteriorating at a rapid pace. It has
now reached the point where Spanish banks have become completely
reliant upon the Bank of Spain and the European Central Bank (ECB)
for funding.
Banks cannot survive without funding. They will either have to raise
additional equity through financial markets or receive a bailout from
the ECB.

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10

April 2012

1982

Everyman
Either way, look for the Euro to come under pressure. And we ask you
not to forget about the Swiss Franc. Its only a matter of time before
the peg is broken and the Swissie soars once again.
Our Strategy
IceCap is confident that stocks remain in a Secular BEAR Market.
While money printing and bailouts may be providing a respite,
investors must recognise that this is temporary. Eventually
governments and policy makers will reduce their interference in
capital markets and equilibrium valuations will be determined by
private investors.
Until that day comes, it is highly likely that every time central banks
pause from money printing, stocks, commodities and non-USD
currencies will decline. These declines will range anywhere from -10%
to -30%, but when they occur be prepared for central banks to once
again introduce yet another money printing program which will first
stabilise markets and then begin to see investors bid stocks up once
again.
Naturally, this cycle cannot continue into perpetuity. Otherwise, why
not simply print money for everyone on everyday of every week.
Eventually something will happen that will be very difficult for the
central banks to control. It may very well be Spain, or maybe Japan.
Or worse still, what if long-term interest rates rose by a mere 3%?
Whatever it is, it will surely test investors fortitude.

At this very moment, markets are stuck in this lull where both Europe
and America have yet to confirm the next round of money printing.
Meanwhile, Canada and the USA just experienced one of the
warmest winters on record which is skewing some of the economic
data from the first few months of the year. Over the next couple of
months, well get to see whether these local economies are indeed
accelerating or simply benefited from pulling forward spending from
the summer months.
We continue to favour bonds over stocks, and will assess how to
reposition portfolio strategies should this market lull develop into
something more sinister.
As always, wed be pleased to speak with anyone about our
investment management capabilities. As well, we encourage you to
share our global market outlook with those who you think may find it
of interest.
Please feel free to contact:
John Corney at johncorney@IceCapAssetManagement.com or
Keith Dicker at keithdicker@IceCapAssetManagement.com.
Thank you for sharing your time with us.

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