History repeats itself. We've all heard that one, and well, it's mostly true. But each generation adds its own touches. Market cycles are the same way -- bear and bull markets keep cycling back around, and each one is just a little bit different. But that doesn't mean we can't learn from the past.
A brief history lesson
John Mauldin's Bull's Eye Investing helps shed some light on market history -- particularly on secular bull and bear markets. Another great text on market history and secular markets is Ed Easterling's Unexpected Returns (which Mauldin references in his text).
For those who haven't read the books, here's a brief primer on secular bull and bear markets. In investing, "secular" means periods of 10 to 20 years. Bull markets are characterized by expanding price-to-earnings (P/E) ratios, falling interest rates, and low or declining inflation. Bear markets, on the other hand, bring contracting P/E ratios, rising interest rates, and high or increasing inflation. Both cycles generally last for 10 to 15 years, though they can sometimes be as short as four years or as long as 20.
Interestingly, secular bear markets generally end at about the same level they began, but with far lower P/E ratios. During the typical 10- to 15-year bear market cycle, there can be violent downswings -- like those we experienced from 2000 to 2002 -- followed by rapid climbs -- like we've seen the past few years.
Are we still in the belly of the bear?
Easterling marks 1999 as the final year of the last secular bull market and the beginning of the current secular bear market. That puts us a little more than 6 years into the cycle. As of June 30, the P/E for the S&P 500 stood at 17.5 -- that's slightly above the long-term average of 16, and well above the historical bear market bottom of 8 to 12. I'd certainly like to think we're at the beginning of the next secular bull market, but relatively high P/Es, rising interest rates, and signs of increasing inflation lead me to believe we're still in the belly of the bear.
In this environment, richly valued companies that don't pay dividends -- like Google
Dividends and valuation
There is no Fool-proof way to avoid the pain of a bear market, but you can take steps to preserve capital and, in some cases, actually make money. Valuation is at the top of the list. Avoiding companies that are priced for perfection or based on unreasonable rates of growth is always important, but even more so when P/E ratios are contracting across the board. Dividends also become more important, because they provide not only provide a return that can offset contracting P/Es, but also cash to purchase additional shares in companies as prices fall and valuations become more attractive.
I have my eye on a few companies that fit this bill: Claire's Stores
Foolish final thoughts
A small fraction of companies will grow through a bear market, but your odds of finding them are slim. You're much better off simply stocking your portfolio with boring dividend-payers that carry below-average P/Es and offer 3% to 5% yields. These companies have the financial strength to fight off the bear market and emerge stronger in the end.
To learn more about dividend-paying stocks, grab a free 30-day guest pass to our Motley Fool Income Investor service. By focusing on dividend-paying companies such as ONEOK
At the time of publication, Nathan Parmelee had no financial interest in any of the companies mentioned. The Fool has a bear-proof disclosure policy.
