Bull markets are rarer than you think
by Mark brown http://www.advisor.ca/images/other/aer/aer_0207_homeintherange.pdf
Markets have been range bound for the past seven years and, if history is correct, they will stay that way for at least another eight years, according to Kim Shannon, value manager and founder of Sionna Investments. “Typically after a major mania condition, the market capitulates, consolidates and goes sideways for a minimum of 15 years and once as long as 30 years,” she told an audience attending an event to promote Shannon’s move to become a partner with Brandes Investment Partners & Co. “Markets are more often range bound,” she says.
When bull runs do occur, they’re generally short and over before most people have a chance to enjoy it. In fact, markets have been range-bound for 100 of the past 134 years. The telltale sign that markets are moving sideways is the average price-to-earnings ratio. According to Shannon, P/E ratios creep up during a bull run before the market levels off. In subsequent years, that ratio is slowly eroded away in one of two ways: The price comes down or the earnings catch up to the price. The last sideways market began in the middle of 1965 when the P/E ratio was pulled down into single digits. Over the next 18 years investors returns flat-lined with an average return of 0.6%. Dividend yields were the main income generator over that period with an average yield of about 4.5%. The two combined produced an average return of 5% per annum. The single digit P/E ratios set the conditions for the next bull run, which took off in 1982.
Currently, the average P/E ratio in Canada rests at about 15. “People don’t want to think that our market could go single digits,” Shannon says, but to her that likely means we are not done with the recovery and capitulation stage. Generally, the commodities index falls during a bull market and rises during a sideways market. This obviously bodes well for Canada, she says. The data available seems to support that assertion. Shannon notes Canada has outperformed most markets during these range bound periods. While she thinks this will continue, she warns investors not to become compliant. “Keep in mind, through these sideways markets you can have individual fabulous rallying years, but you get much more frequent bear markets,” she says. And while it’s possible to set new record highs on the market, they almost never sustain them. This is one of the reasons why Shannon doesn’t like to make year-to-year predictions for the market. It also says something about how this successful long-term value manager invests.
The key theory for value managers is reversion to the mean, she says, that is, a stock companies trade will do nothing more or nothing less that what it has tended to do before. By looking at how the stock has performed relative to the market in the past, Shannon can make a prediction on how it’s going to behave in the future. “In simple terms,” she says, “what we do is search the investable universe looking for dollars that happen to be trading at $0.70 or less and, if the risk factors are acceptable, patiently waiting for them to go back to a dollar.” In a recent interview she talks about her reluctance to make broad market predictions. “What happens in a year is more noise than anything else,” she said. Overall, when it comes to the market Shannon has always been something of a pessimist when it comes to setting predictions for the market. “My clients know that I tend to wear bear coloured glasses all the time,” she said. “When I make predications and forecasts, if they add a dose of optimism, they’ll probably get it about right.”