To show how bad the environment has been for stocks, the most recent data shows that the 30-year return on Treasuries has risen above that for stocks for the first time since before the U.S. Civil War!   Long-term government bonds have gained 11.5 percent a year on average over the past three decades, beating the 10.8 percent increase in the S&P 500    Stocks had risen more than bonds over every 30-year period from 1861 until now.  When I saw this data point, it reminded me of a chart I put in a market comment back in late 2008 and which is shown below.

Historic Buying Opportunity in Context of Past Century

Markets had dropped so sharply in late 2008 that the 10-year return on the S&P500 had gone negative for only the 3rd time in 100 years; the other two being in the late-1930s and again in the mid-1970s.  As we all know, markets then recovered over the following two years, seeing a near-doubling in prices from the lows to the peak in April this year.  Our point here is that market volatility has increased dramatically over the past few years and this ends up creating more extreme readings on traditional data series.  Given that markets do trend towards ‘mean reversions’ over time (i.e. average valuation readings), these extreme data points, rare in occurrence, generally mark turning points in prices and are generally safer times to go against that recent trend despite the fact that it always seems like the ‘wrong’ or ‘completely non-consensus’ view to take at the time.  We continue to see the current environment for stocks (and particularly stocks versus bonds) as a repeat of this type of occurrence.  The fact that stocks have done this poorly over the long-term versus bonds makes the risk in shifting assets in the other direction much lower.

One of the key reasons that we remain extremely bullish on stocks over the longer term is the continued growth in the emerging economies.  These are secular (long-term directional) moves which do not reverse direction until the secular trend is completed.  This is shown in the chart below, one that we resurrected from our monthly comments last year.  Industrialization in Europe, the U.S. and Japan increased dramatically following the end of the 2nd World War and that lead to a period of above-average global growth and strong stock markets for a 26-year period.  A similar expansion had occurred earlier in the century driven by the advent of railroads in North America.  Another period of economic expansion began in 1974 and drove stock prices substantially higher over the following 26 years, driven in large part by global expansion of consumer brands and the advent of the technology era.  This ended in 2000 with the collapse of the technology bubble.

Will Emerging Economy Growth Support a New Secular Bull Market in Stocks?

We continue to believe that we are on the cusp of another such period of global expansion that will be lead by the growth of the emerging economies, which now account for almost 40% of the global economy.  Stock prices, supported by improved profitability and low interest rates, should follow suit.  Sectors expected to lead include those that are used most intensely in the emerging markets of the world, including basic materials, energy, industrials and technology.  Financial services, in our view, remain in a longer-term downtrend and will shrink relative to the rest of the economy.  Although there will be periods of out-performance for that group, we do expect financial stocks to lag the overall market during this secular period of growth.

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