Two weeks ago I posted a video on YouTube declaring that I thought we were in the midst of a new bull market. I went on to say, in order to tell if we have entered a new bull market it is best to try and determine if we have seen a market bottom. November 20, 2008 was the day the S&P 500 reached 752. As of January 6, 2009 when the S&P 500 reached 934.7, it represented a 24% advance from the November 20th low. Technically, once an advance of 20% or more is underway that is a new bull market. But in an effort to be thorough, I went through five criteria I look at to determine if we were in fact in a new bull market.
Truthfully, I stole the criteria from Benjamin Graham’s The Intelligent Investor. In the book, Chapter 8, “The Investor and Market Fluctuations”, Graham explains how to recognize market tops. He gives five criteria. I simply turned those criteria on their head and replaced one with another I think is more relevant (at least to me). The criteria were:
1. A significantly low price in the market index.
From Oct. 9, 2007 through Nov. 20, 2008, the S&P 500 declined 52%, making it the third-worst bear market since the 1929-32 crash which saw a decline of 54%. The only other decline more significant than the ones just mentioned was 89% during the Great Depression. Additionally, the calendar year decline of 39% was only surpassed two other times in (1931 and 1937) in over 180 years. In other words the severity of the decline indicates that we are at a significantly low price.
2. A significantly low P/E on the market
At the 752 level, the S&P 500 was trading at a P/E ratio on trailing operating earnings per share of 11.5x. This is equal to the lowest operating P/E ratio in the 20 years that S&P has been tracking operating results and significantly lower than the average operating P/E ratio of 19.3x since 1988.
Another P/E measure is the Graham P/E (named for Benjamin Graham) which uses an inflation adjusted 10-year average for earnings. For the nine previous bear market bottoms the Graham P/E averaged 14.4x. At the 752 level in the S&P 500 the Graham P/E clocked in at 12.3x. This was lower than even markedly low P/Es.
3. High Stock market dividend yields
versus relative to long-term bond yields
Dividends paid by Standard & Poor’s 500 Index companies in the 12 months prior to December of 2008 amounted to 3.5% of the benchmark’s closing value yesterday. In early December, the 10-year yield fell as low as 3.4%. Intuitively, stocks should yield more than bonds as they represent the more volatile investment. However since 1958, 10-year notes have yielded on average 3.7% more than stock dividends. The present condition, dividend yields higher than bond yields, serves as an indicator stocks are priced the lowest they have been relative to bonds in 50 years.
4. Low Level of margin accounts
Margin is commonly used in a speculative manner. When the market is rising, buying stocks with borrowed money can and does juice returns. But in a declining market, they can be a death certificate. Margin accounts declined 47% from July of 2007 to November of 2008.
5. High volatility in the market
The best measure of volatility we have today is the CBOE VIX. The VIX, is also called the fear index. When it is high it indicates there is a plethora of panic selling in the market driving prices down. Market prices and the level of the VIX move in opposite directions. Historically, a VIX above 20-25 meant there was a lot of selling. Since the high of October 2007 to date, the VIX has averaged almost 32 and even reached an intraday high approaching 90. Warren Buffett himself even indicated he had never sell panic like this in all his years of investing. Panic selling usually means market bottoms.
Although we have seen the market pull back from the 934 price it reached on January 6th, it has not dipped below 800 since then. If history is any indicator, we are in the first few days of a new bull market.
Disclosure: I and the clients of Brick Financial Management, LLC are own shares of iShares S&P 500 Index ETF but positions can change at anytime.