Briefing.com: Six Secular Trends Working Against Stocks
07-May-02 11:38 ET
[BRIEFING.COM - Robert V. Green] The great bull market of the last 20 years had a number of secular trends working to help build the market. Most of these trends have played themselves out and stocks will have to advance without benefit of these stong drivers going forward.
The Great Bull Market
The 18 years from 1981 to 1999 were the greatest years in stock market history, bar none, with the years from 1995 through the end of 1999 having no parallel. You lived through the best years ever!
Behind this incredible bull market run were major secular trends that drove the prices of stocks. Unfortunately, the strongest of these trends have essentially lost their steam. These trends were:
Decline in inflation
Decline in interest rates
Rise of the 401(k)
Growth of technology
Rise of stock ownership
Shift from bank savings
Rise in valuation (a result of the other trends)
Every one of these trends contributed greatly to the tripling of valuations over 18 years.
The Decline In Inflation
At the beginning of 1980, inflation stood at 13.3%.
Today, inflation has fallen to just 1.6%.
The long term decline in inflation made economic investment more attractive, driving capital to equity investment. It also makes earnings more predictable, and reduces the fear of inflation erosion of capital. All of these made stocks more attractive, compared to the world of the 1970s, and therefore pricier.
The graph below shows the decline of inflation during the great bull market run. A continuation of this trend would lead to deflation, which is negative for equities, as deflation weakens company's pricing power.
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The Decline In Interest Rates
In 1982, 30 year Treasury bills sold for 14%. (Truly excellent investments as the original holders have 10 years more to go at a risk-free 14% annually).
Today, 30 year Treasury bills sell for just over 5%.
The decline in interest rates makes capital cheaper. It also makes a decision to invest in economic activity versus financial activity easier. The declining interest rate environment drove capital to equity investment and raising demand for equities.
The graph below illustrates the dramatic long term decline in rates. This "pump-primer" of all kinds of economic activity can't be duplicated from today's levels.
The Rise of the 401(k) and IRAs
In 1981, the 401(k) plan did not exist.
Today, 401(k) plans account for $1.8 trillion in assets. With a total market capitalization of $19 trillion, and a total bond market of $13 trillion, 401(k) plans now account for approximately 6% of the entire financial assets of the market place.
The graph below shows the tremendous growth of 401(k) plan assets.
In addition, the asset allocation mix of 401(k) plans has shifted dramatically towards equities during the last ten years, as shown in the table below.
401(k) Assets 1990 1994 1998 2000 Q3 01
Equity Percentage 34% 45% 60% 67% 61%
Source: SPARK, Society of Professional Actuaries and Record Keepers
The shift toward equities combined with the continual influx of new dollars into the market has been a strong driver of equity demand for the past 10 years.
This growth of 401(k) assets is the most likely of these trends to continue, however, a shift away from a 2/3 allocation to equities is likely to evolve for two reasons:
A discontent with equity returns over the past two years
The demographic shift of workers becoming retirees and shifting assets towards income producing instruments
The Rise of Technology
In 1981, the technology sector made up just 7% of the S&P 500. Today, technology makes up 16% of the overall market, but during the bubble era, it constituted a full 31% of the entire market capitalization.
The explosive growth of technology was a strong economic driver of our economy. Much of the tremendous returns of equities came from the establishment of technology as a driver of the economy. The quadrupling of technology as a percentage of the market from 1981 to 1999 is not going to happen again from today's levels. Technology has matured as a force in the economy compared to 20 years ago.
The Rise of Stock Ownership
During this great bull market, stock ownership by individuals spread tremendously. A combination of the growth of stock options and employee stock purchase plans, along with the attraction of the bull market returns, has brought direct stock ownership to many more Americans.
The graph below shows the growth of direct stock ownership by individuals over the past 20 years.
Source: Securities Industry Association, Investment Company Institute, Federal Reserve
The numbers show millions of individuals or households. There are approximately 200 million adult individuals and 115 million households in the US. While some continued expansion of direct ownership of stocks can be expected, a doubling of the ownership, which happened since 1980, is unlikely.
The Shift From Bank Savings
From 1975 to today, a major shift occurred away from banks to direct investing by individuals. The stock market was the beneficiary.
The household ownership of financial assets shifted away from banks and towards equities and mutual funds. The mutual fund era of 1985 to 1995 was explosive, followed by the stock market explosion in 1995 to 2000.
The amounts are staggering. For example, individual ownership of equities in 1975 totaled just $493 billion. Today (data is as of Q2, 2001) the total is $6.2 trillion.
The table below shows percentage ownership of individual financial instruments, by type. For example, in 1975, total ownership of financial instruments by individuals totaled $1.7 trillion. Bank deposits amounted to 55% of that total, or $935 billion.
Bank Deposits Equities Bonds Mutual Funds Money Markets Total Value
1975 55% 29% 14% 2% 0% $1.7 trillion
2001 23% 40% 11% 19% 7% $15.6 trillion
The graph below illustrates the same data as in the above table.
Source: Federal Reserve Flow of Funds Accounts, SIA
Bank deposits no longer attract the bulk of household assets. The shift from banks to stocks and mutual funds has been a strong driver of demand for equities. While further erosion of bank deposits as a desirable investment is possible, the "great raid" on banks is probably close to over. Far more likely is a flattening of the equity and mutual fund percentages.
The Rise In Valuation
In April of 1980, the Price/Earnings ratio on the S&P 500 was just 6.7, the all-time low in the post war period. The high during the bubble was 34.7 in June of 1999. Today the value stands at 43.8, higher than the bubble era. Ignoring for a moment what that implies about valuations today (a separate Stock Brief), you can only conclude one thing: there isn't much room for multiple expansion going forward.
As the graph below shows, the trend has been upward since 1981. (Data in this graph stops at Q3 2001).
It could well be argued that the first six trends caused the rise in valuation, and that the valuation trend is more of a measure of the effect of the other trends.
Either way, it is hard to argue that stock prices have a lot of room for multiple expansion, as they did in 1981, the start of this great bull market.
Stocks will have to produce returns on business success, with little aid from multiple expansion going forward. This is going to make tripling, even doubling, of a stock investment extremely rare, especially in large cap stocks.
The Conclusion
All of the secular trends listed above were strong drivers of the market for the last 20+ years. The congruence of all of them produced strong buying demand, which helped push the market prices and valuations higher, as well as allocate more capital to equity investment, which drives the economy.
Every one of these trends is closer to the end of the trend than the beginning. This means the price-pushing power of each has weakened considerably.
Does this mean that stocks are headed lower?
The absence of these trends as major forces does not mean, by itself, that stocks are headed lower. But it does mean that stocks can not count on these major secular trends to help drive prices going forward.
These solid drivers, listed above, won't be the ones pushing the market higher over the coming years. While some of the trends may continue the current trend, and not reverse, the major driving effect on stocks, and valuations, has already happened.
Comments may be emailed to the author, Robert V. Green, at rvgreen@briefing.com |
