Ed Easterling of Crestmont Research boils down his views on long term markets to 12 rules of secular stock market cycles. In case you are unfamiliar with Ed’s work, several books, including Unexpected Returns: Understanding Secular Stock Market Cycles; he also wrote Probable Outcomes.

Here are Ed Easterling’s 12 Rules of Market Cycles:

1. Secular cycles are driven by the inflation rate (deflation, price stability, and higher inflation)

2. Secular bulls occur when P/E starts low and ends high over an extended period

3. Secular bears occur when P/E starts high and ends low over an extended period

4. Cyclical bulls and bears are interim periods of directional swings within secular periods

5. Cyclical cycles are driven by market psychology, illiquidity, or other generally temporary condition(s)

6. Time is irrelevant to the length of secular stock market cycles

7. Secular bulls require a doubling or tripling of P/E

8. Secular bears occur as P/E stalls and falls by one-third to two-thirds or more

9. When real economic growth is near 3%, there is a natural floor for P/E between 5 and 10, a natural ceiling around the mid-20s, and a typical average in the mid-teens

10. If economic growth shifts upward or downward for the foreseeable future, the natural range moves upward or downward, respectively

11. Inflation drives P/Es location within the range; economic growth drives the level of the range

12. The stock market is not consistently predictable over months, quarters, or periods of a few years; the stock market is, however, quite predictable over periods approaching a decade or longer based upon starting P/E

Good stuff. That’s an interesting take on broad cycles.

Category: Cycles, Earnings, Investing, Markets, Psychology, Rules

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11 Responses to “Ed Easterling’s 12 Rules of Market Cycles”

  1. Francisco Bandres de Abarca says:

    “Time is irrelevant to the length of secular stock market cycles.”

    The amount and duration of leverage introduced into a financial system, and the consequent withdrawal and the associated rapidity of deleveraging, however, clearly would be bound to the length of secular market cycles.

    When the men of easy advantage are driven from the field by men and women of ability and competence–that also is a critical point on the turn. How can we know when such a point is reached? Well, I suppose one way marker may be when we no longer see Alan Greenspan being invited before Congressional committees for advice on any given economic matter.

  2. SOP says:

    I’m confused.

    Does “Ed’s 12 Rules of Market Cycles” apply to both the Growth Phase of the Industrial World AND to the Contraction Phase of the Industrial World?

    Does Ed know What Time it is – re. “The BIG Picture” ?????

    Can you spot what’s wrong in this picture?

    http://www.crudeoilpeak.com/wp-content/gallery/iea_weo_2010/iea_weo_2010_crude_oil_plateau.jpg

    Paging Samsam Bakhtiari (RIP Dr. B.)
    —-
    “But even during that rather benign T1, the unexpected might become the rule and the orderly ‘Pre-Peak’ rapidly give way to some chaotic ‘Post-Peak.’

    “”The major palpable difference between the four Ts is their respective gradient of oil output decline.” My interpretation of that comment is that at each “transition” point where the gradient changes, we might view that as the “phase change” analogous to, say, frozen water melting, or hot water boiling.”

    http://www.dailyreckoning.co.uk/economic-forecasts/dr-ali-morteza-samsam-bakhtiari-and-the-four-phases-of-transition.html

    ——-

    Is it true that frogs do not notice the water is getting hot, and end up boiling to death – while writing rules for a cycles that no longer exist?

  3. ValuValu says:

    Doesn’t 2) and 3) simply mean “A bull market occurs when stocks get more expensive over an extended period of time, a bear market occurs when stocks get cheaper” ? Duh…

  4. SOP says:

    A Battle for Oil Production Is Brewing

    Oil wells produce less each year; Exxon’s oil fields, for example, are declining by 5 to 7% each year, which means the company needs to add 200,000 to 300,000 barrels of production a day just to break even. This year, Exxon has not come close – its production levels are down 8% compared to a year ago. Some of the production decline stems from contractual limits on Exxon’s production, but even without those limits production would have still been down more than 1%. Over the first nine months of the year, Exxon’s production averaged 2.33 million barrels of oil per day, the company’s lowest average since 2005.

    Things are even worse for other major oil companies. BP said oil production dropped 10.6% in the quarter, in terms of barrels of oil equivalent (BOE). Shell’s BOE production fell almost 2% in the quarter. ConocoPhillips produced 6% fewer BOEs…

    http://www.creditwritedowns.com/2011/11/oil-production-battle-mergers.html

  5. SOP says:

    A Battle for Oil Production Is Brewing

    Oil wells produce less each year; Exxon’s oil fields, for example, are declining by 5 to 7% each year, which means the company needs to add 200,000 to 300,000 barrels of production a day just to break even. This year, Exxon has not come close – its production levels are down 8% compared to a year ago. Some of the production decline stems from contractual limits on Exxon’s production, but even without those limits production would have still been down more than 1%. Over the first nine months of the year, Exxon’s production averaged 2.33 million barrels of oil per day, the company’s lowest average since 2005.

    Things are even worse for other major oil companies. BP said oil production dropped 10.6% in the quarter, in terms of barrels of oil equivalent (BOE). Shell’s BOE production fell almost 2% in the quarter. ConocoPhillips produced 6% fewer BOEs…

    http://www.creditwritedowns.com/2011/11/oil-production-battle-mergers.html

  6. ToNYC says:

    I thought Rule No. ! was to bet on what’s working and reverse position at the first sign of rationalization or justification why it’s no longer working. Twelve of anything sounds like dough nuts.

  7. theexpertisin says:

    Lots to remember, but they make sense.

    What happened to the good old days when investors followed Marty Zweig…”don’t fight the tape/don’t fight the Fed”? That approach earned him a huge yact in Ft. Lauderdale.

    Or Bogle?

  8. philipat says:

    CNBS etc., in an obvious effort by most of their sell side/stock salesmen guests (Who are never held to account) to make stocks appear “Cheap”, now shamelessly use EBITDA as the “E”. This is not correct, GAAP (As reported) earnings are the correct level for “E”. Obviously using the (Higher) EBITDA earnings will make the P/E smaller, hence “Cheaper”.

  9. herewegoagain says:

    “The stock market is not consistently predictable over months, quarters, or periods of a few years…”

    GAMBLE: to play games of chance for money

    If we accept Mr. Easterling’s last rule, and are in accord with the Oxford definition of GAMBLE, is not short term “investing” simply high falutin gambling?

  10. [...] Ed Easterling’s 12 Rules of Market Cycles (The Big Picture)  [...]

  11. TheDraconian says:

    I just made a bunch of scatterpoint charts relating CURRENT trailing TTM PE’s with FUTURE returns. I looked at 3, 5, 7, and 10 year windows to see if current PE’s had any predictive worth on their own. There was less correlation than would have I thought.

    HOWEVER, when you get near extremes, there does appear to be some predictive value, especially if you use a normalized PE like the Shiller PE. And this seems to be at the heart of several of these rules about secular cycles.

    Here’s the article with the charts over at Seeking Alpha.
    http://seekingalpha.com/article/305935-should-you-really-care-if-stocks-are-cheap

    It’s a simple study, but an interesting place to begin additional research on quantifying some of these Easterling rules.