What is interesting is how everyone assesses the economy in ‘real terms’ but the equity market in ‘nominal terms’. The reason why economists prefer to focus on ‘real variables’ is so that the trend can be examined net of the effects of inflation (or deflation). Standards of living are a ‘physical’ concept – how many widgets are we producing per capita? How far will the dollar go? These are questions that require ‘real’ variables. So, when we normalize the long-run chart of the S&P 500 with the Consumer Price Index, and look at the stock market in real terms as we do with output and employment, it tells a very interesting, if not disturbing, tale. Here is what jumps out at us:

1. We are in a secular bear market that began in August 2000, not a cyclical downturn that began in October 2007. This is all part of a secular downtrend that is nearly nine years old. Over that time, the S&P 500 in real terms has collapsed 53%. This compares to the 63% decline in the stock market, on an apples-to-apples comparison, in the last secular bear market from 1968 to 1982. If we were to repeat that bear phase in terms of magnitude, we are over 80% of the way through; in terms of timing, roughly 65%.

2. That last secular bear market from 1968-82 took place after a war and a heavy incursion into the economy by the government (LBJ’s ‘Great Society’ then; Obama’s current ambitious economic plan). It also followed a period of rampant productivity growth brought on by the rolling out of an extensive transportation network (interstate highways then, information highways now). It also followed on the heels of a major runup in private sector debt-to-GDP ratios (the introduction of the credit card). That 1968-82 secular bear market also followed a massive secular bull market that saw the S&P 500 soar fivefold over the prior 20 years. This time around, from the 1982 low to the 2000 peak – again, almost a 20-year secular bull run – the market surged nearly eightfold in real terms.

3. It is never easy to try and time the bottom of anything, especially the equity market. In that last secular bear market from 1968-82, 78% of the entire bull phase was wiped out in real terms. A repeat reversal this time around would imply an ultimate low of 2.76 on the real level of the S&P 500, versus the current level of 4.10 (imagine that the stock market, in real terms, is twice as high now as it was at the bubble peak back in 1929). If indeed we are in either a stable price or deflation environment, this would suggest another 32% downside to the S&P 500 (i.e., a decline towards 460 in ‘nominal’ terms). Alternatively, for the S&P 500 to bottom at today’s level of 680, assuming we were to see a similar retracement this cycle in real terms to what we did in the last secular bear market, we would need to see the inflation rate soar to 15%. Considering that the starting point is 0%, we wouldn’t be holding our breath, even if the Fed is successful. Even a 5% inflation rate would imply a test of 600 on the S&P 500 in nominal terms in the coming year.

4. Finally, for three decades prior to the equity culture that took hold in the late 1980s, around the same time that Oliver Stone brought us Gordon Gekko, the S&P 500 in real terms was between 1.0 and 3.0, shall we say, 100% of the time. Getting above 3.0 was simply unheard of until 1992, and today, even after this stunning decline in valuation, the S&P 500 still stands above 4.0. Again, getting back to historical norms of closer to 2.0, without inflation, would mean not a 30% drop from where we are today, but closer to a 40% decline.

5. The stock market, up until the mania that began nearly three decades ago, basically kept pace with inflation. It has actually been the rule, not the exception, for the S&P 500 to go through very long stretches at a time stagnating in real terms – for example, the CPI-adjusted S&P 500 was no higher in 1985 than it was in 1955. And for those trying to time the market for the next sustainable bull phase, note that the very best buying opportunities in the past 80 years occurred when the S&P 500 bottomed in a range of 0.5 to 2.0, again in real terms. So here is the bottom line We have to understand how far the secular bull market overshot to the high side. At this stage, the S&P 500 may decline another 30-40% from here with no inflation as the market continues on its mean-reverting journey; or it may manage to stabilize with years of 5%+ inflation; or perhaps something in between. From our lens, since gold is inversely correlated with BOTH the equity market AND inflation, you can see why bullion is in, and likely to remain in, a major secular bull market.