1. The Roller Coaster Analogy: An appropriate analogy for a long term secular bear market is a roller coaster ride. You slowly climb that hill, and then suddenly you are whisked back to the ground, around and around you go, then back up again slowly, and then another rapid descent, ending up at the place where you started the ride.
For a buy and hold investor who is enduring the vicissitudes of a long term secular bear market in stocks, nothing is accomplished after fifteen years, or longer for the worst kind of secular bear markets such as the Great Depression. Money is made for the buy and hold investor only in long term secular bull markets. Money is invariably lost for those investors during long term secular bear markets after an adjustment is made for inflation.
The classification of a market as a long term secular bear or bull markets will have an impact on my asset allocations and will influence my trading strategy. In a long term bull market, such as the one experienced between 1950 to 1966 (or 8/1982 to 10/97), stocks will be over weighted, and the trading will be infrequent. The mantra- buy on the dips- makes sense during such periods, but sell on the rips is ultimately a counter-productive strategy. Possibly, after a strong run in stocks, the overall allocation to stocks could be reduced some and moved into other asset classes that have not experienced the same robust moves. Then when there is a correction of 20% or more, some of that money can be returned to stocks. It is more of a nip and tuck strategy, compared to what has to occur during the long term secular bear cycle.
The shifts in assets allocations have to be far more aggressive during the 15 or so years in the bear cycle, more attuned to what is actually occurring in the market rather than the particulars of an individual's situation. A lot of trading has to be done to capture the cyclical bull moves that may last 1 to 3 years generally (my trades over the past year are over 800). Why? The bear response to that move will be to take all or most of the gains made in the bull move away, and sometimes even more. That is precisely what happens in every long term bear market.
The cyclical bull moves in a bear market have had some of the largest percentage gains in the history of the stock market, and those gains have occurred over a relatively short period of time. This would include, for example, the cyclical bull moves after the market hit bottoms in 1932, in October 1974 and in March 2009, all are huge counter-moves to the catastrophic phase of the long term secular bear market. That catastrophic phase can occur at anytime in the secular bear market, at the start as in 1929-1932, or in the middle as in October 1974, or hopefully nearer the end as in in October 2008 to March 2009. Some long term purchases can be made by those with capital to spare and a strong stomach for the roller coaster ride characteristic of the long term bear cycle. I am defining the catastrophic phase as a decline of more than 50%.
For those who recognize the existence of a long term bear pattern, and learn to accept it for what it is and to develop coping strategies, cash will become an important asset class integral to a successful strategy of navigating the frequently wild up and down roller coaster ride characteristic of the long term secular bear market. In the long term bear cycle, I would start building my cash allocation to around 5% to 10% after 1 1/2 to 2 years into the cyclical bull move, and then build it up more as the cyclical bull move extends in time. I hit about 30% in the late fall of 2007. Besides preserving capital, the primary purpose is to have funds to invest in the very strong downdrafts which will occur on more than one occasion, without having to sell one stock which has declined a lot to buy another one. Many would say that this is market timing. I would just say that there is some market timing involved in this type of re-allocation as a matter of necessity. My goal is to advance my capital position in both long term bull and bear cycles.
Unlike Jeremy Siegel who has stubbornly stuck to his thesis and virtually all financial professionals and planners, I at least recognize that the plan for the long term bull cycle can not be the same as the one for the bear cycle. In short, I am not inclined to ignore historical evidence that would be considered critical by intelligent human beings with a limited life span, and importantly a limited period where serious money can be saved for retirement. To Professor Siegel: Time for a Re-Think
I keep referring to the following data about historical annualized returns adjusted for inflation (and after reinvestment of dividends) to drive this point home. I was born in 1951. I did not have any money to invest that year and for many years thereafter. If I did have a boatload of money to invest on the date of my birth, then possibly Siegel's thesis would make some sense. I started to accumulate some money by saving in the 1970s. Most people do not have 50 or 60 years to save serious money, ride out the up and down cycles in the stock market, until the accumulated money has to be spent in retirement, hopefully avoiding one of those 50% declines shortly before or after retirement.
I retrieved the following data at Annualized Returns of the S&P 500 by checking the box "adjust for inflation". The site assumes dividends generated by the companies will be invested in the S & P 500 index, like buying the ETF SPY and then reinvesting the dividends:
1/1/1949 to 12/31/1965: 14.4% annualized after inflation
1/1/1982 to 12/31/1997 (part of those years I would not include): 14% annualized after inflation
Now let's look at some of the bear data, and these are significant durations in an individual's life:
1/1/1966 to 12/31/1981= -1.04% annualized
1/1/1998 to 12/31/2008: -1.44% annualized
I increase the annualize return from 1998 to .44% by including 2009. But since this is not over yet in my opinion doing my best to channel Jeane Dixon , I suspect the return will end up being negative on an annualized basis. And, inflation is starting to pick up too which would make a long term stagnant return even worse.
The underlying reason for the ebb and flow of these cycles is the flawed decision making process made by humans which never changes in any meaningful sense. The seeds of the bear market are planted during the bull phase, a truism which is true. The weeds will be apparent for those willing to look around when the market is in the later stages of the bull cycle. Does it really require foresight to realize, for example, that a 20% compounded rate of growth in housing prices, far outstripping the increase in income, is not a sustainable trend? Greed, stupidity and ignorance start to rule the roost in the dying spasms of the long term secular bull market. Some of the stupidest people on the planet are also among the most greedy, the infamous Masters of Disaster who have the power to visit destruction and chaos on the masses. Mistakes of the past may not only be repeated but also magnified in an orgy of this time is different group think. Generally, fifteen years is about as long as mankind can go without seriously mucking things up in a bad way. So, as a rule of thumb, fifteen years into a long term bull cycle will require some downward adjustment in my stock allocation no matter what bull song is being song by the masses. The difficulty will be in deciding where to send the money. The next long term bear cycle may be different on the asset classes likely to hold and increase their value. U.S. treasuries may not be the place to hide next time, but an asset class to avoid.
If my crystal ball is not too cloudy, I would expect range bound movement in the S & P 500, mostly between 950 to 1250, through 2012. By 2013, most of the serious issues involved with deleveraging by governments and individuals in developed countries will be resolved. It is Europe and the U.S. who are the sources of the problems in need of a long term workout. When the near completion of that workout is coupled with the expanding middle class in emerging market countries, and possibly an accelerated pace of technological innovations that improve productivity and lower costs, the underpinnings of the next bull cycle will start to dominate over the remnants of the cancerous Age of Leverage, and a new long term bull cycle can then start. The timing of this transition is a little mushy without question. If I am generally right about the timing, those with strong stomachs and even stronger hands could start to look for buying opportunities for long term investments over the next two years, assuming they missed the opportunities in the Spring of 2009, recognizing that it will be impossible to time precisely the start of the next bull cycle.
{I found this post on Sunday that contains some charts and discussion about long term cycles. Cycles I would date the current long term cycle as starting in 1997, whereas the author of the preceding post dates the current long term bear cycle as starting in 2000. October 1997 marked the start of an unstable VIX pattern that lasted for an extended period of time. The highs of 1997 also roughly mark an area where the current bear cycle returns after cyclical moves up, except for the catastrophic phase which took the S & P 500 briefly to 666. (5 year chart May 2005 to present: S&P 500 INDEX,RTH Index Chart - Yahoo! Finance; and 12 year chart from August 1997: See Chart in Continuation of the Long Term Secular Bear Market Pattern ). This is why I date the end of the 1982 secular bull market in October 1997. That is when the market started the whipsaw pattern of cyclical bull moves followed by cyclical bear moves, with the end result of going nowhere which is the defining characteristic of a long term secular bear market}
2. Unhelpful Comments: There have been a number of comments made by important people over the past few days that have added to angst.
Paul Volcker, one of the few economists in the world with gravitas, told students in London that the debt problems in Europe "risk the potential disintegration of the Euro". Mail Online
The President of the European Central Bank, Jean-Claude Trichet, told a German paper that the economy is in the "most difficult situation since World War II or perhaps even World War I".
Josef Ackerman, head of Deutsche Bank, said on German TV late Thursday night that he was unsure how Greece could repay its debts. WSJ.com
"This is why I date the end of the 1982 secular bull market in October 2007."
ReplyDeleteJust a quick correction of a typo as I think you meant October 1997, not 2007 as the end to the secular bull started in 1982.