The Long and Winding Road

The long and winding road that leads to your door,
Will never disappear,
I've seen that road before it always leads me here,

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Leads me to your door.

A common truism about bear markets -- that they can only be resolved via time and price -- is widely misunderstood. While predicting future prices is a dangerous affair, it’s even more difficult to grasp the other element of resolution - time, or how long it will take to reach bottom.

But when earnings estimates are nearly impossible to guess, we must revert to other, more tangible measures: price/tangible book value (note that I use tangible book value, which excludes nearly worthless assets like goodwill), price/Tobin’s Q Ratio (Tobin’s Q is the “replacement value” of a particular company), and price/free cash flow.

My price targets over the past few years were for an initial stop of the S&P 500 at 750, then 600-650, then 500, then the eventual 450 level. Despite my expectations of miserable earnings and global deleveraging, I’m sad to say that my ultimate targets may have actually been a bit too optimistic. My price target now for the S&P 500 is in the 350-400 range, which is still a decline of 40-50% from current levels.

My target in terms of time for the ultimate S&P low has been early to mid-October 2010, which coincided with the typical low seen in October of the second year of a presidential term.

As longtime readers may recall, I find the presidential cycle to be the strongest and most predictable cycle. A report out of Pepperdine University suggested that, since 1952, if you had been invested in the S&P 500 from Day 1 of a presidential cycle until mid-October of the term’s second year, a $1,000 investment would have turned into roughly $650, without even adjusting for inflation.

If, on the other hand, you had invested from mid-October of the term’s second year and sold on the last day of the term, your $1,000 would now be worth $71,000. Without a doubt, this is due to stock prices, economic circumstances, and Gallup approval ratings, all of which are amazingly synched.

Even if we’re lucky enough to estimate the ultimate bear-market bottom, this is only part of the equation. Making it through a bear market with the bulk of one’s capital intact is obviously the first priority. Buying at depressed levels, even within the confines of a secular or super-bear market, can be highly profitable.

Assuming we get the estimate even close to correct, we must then again guess just how long it will take before we start the next secular bull market. My guess is it will be at least 10 to 15 years from the secular bear market low, which I guess will be in 2010.