The New Normal: A Secular Bear Market

Includes: INTC, TXN
by: Elliott Gue

I get a kick out of reading commentary from the perma-bears. No matter what the market does, how bullish the economic data or how strong corporate earnings results, these pundits are always looking for the next calamity that’s going to send the market back to its March lows or push the global economy into a double-dip recession.

These commentators typically have their days in the sun every few years when the market gets hit; as you might expect, last year’s sickening collapse was one of the best years ever for the permanently ursine. Of course, when the market starts rising the same cadre of bears will fight the tape and tell investors they’re ignoring the coming crash.

Many like to claim they “called” the market’s collapse, though a cursory examination reveals many have been making the same basic call for years. And they’re also guilty of an even more egregious sin: missing out on the huge run-up in global stock markets this year by refusing to adjust to cyclical changes in the market.

Let me cut off the flood of e-mails telling me I’m whistling past the graveyard in a bullish daze. I don’t find the bearish commentators amusing because I disagree with them. In truth, many of the more common bearish talking points are absolutely dead-on.

Chief among the concerns: The US consumer is overleveraged and won’t be the engine of global growth in future.

Source: Bloomberg, Personal Finance

US consumers have borrowed at unprecedented levels in recent years, encouraged by the Federal Reserve’s easy money policies that inflated a credit bubble. As you can see in “Borrowing Boom,” in the late 1950s total US household debt--such as mortgages, credit cards and auto loans--stood at less than 40 percent of gross domestic product (GDP).

That ratio rose to roughly 45 percent by the mid-’70s. But just as the savings rate dropped precipitously post-1982, debt levels steadily increased and were near 100 percent in 2007.

The pattern is clear: Americans cut their savings and borrowed money to fund consumption. This alone accounts for the consumer’s resilience and willingness to buy the country out of every contraction over the past 25 years.

But that trend has ended abruptly. The US savings rate jumped to as high as 6.2 percent in recent months, and the household debt-to-GDP ratio has begun to decline as Americans pay down their debt.

Because the excessive debt burdens of the past few years are unsustainable, this pattern of deleveraging is likely to continue for at least a few more years. The US consumer isn’t spent but will no longer drive economic growth.

Meanwhile, US federal deficits are at banana republic levels, which will ultimately mean higher interest rates as foreign investors demand a higher return to lend yet more money to the US government.

Deficits are likely to go higher in the near term; regardless of what you might think of proposed health care reform, the US stimulus package and various financial bailouts, it’s obvious that all have added to America’s government debt binge.

All of this is reflected in the value of the US dollar. The dollar will likely rally from time to time, but it’s tough to see the back of the dollar bear market broken anytime soon.

I could chew oodles of bandwidth detailing the challenges the US economy faces in coming years. Suffice it to say that I see the US stuck in a secular bear market for years to come.

But here’s where I differ from the perma-bears. Discussing long-term headwinds is an interesting intellectual exercise, but it’s not going to make you a dime, or even a euro-cent. As investors, our mission isn’t to dig up new indicators to justify a long-term bearish position.

The mission is to make money. This means looking for opportunities to make money even in less-than-perfect market conditions.

In all fairness, I’ve been careful to direct my comments at “perma-bears” rather than bears in general. I firmly believe that all investors should be aware of the long-term headwinds facing the economy. And there are plenty of outstanding bearish commentators who are willing to suspend their beliefs and take advantage of opportunities as they arrive. All investors should read these commentators and pay attention.

My point is simple: As popular as they are today, the perma-bears are every bit as ridiculous as the cheerleaders who rode the market all the way down after the collapse of the tech boom in 2000 and the more recent credit debacle.

Recognizing the long-term headwinds facing the US, investors can still make money in the current environment. Here are a couple of the basic strategies I’d recommend.

Flexibility/Willingness to Sell. Look back at charts of markets in prior secular bear phases such as the S&P 500 from 1968 to 1982 and after 1932 and Japan’s Nikkei 225 in the ’90s.

In all three cases, the market’s trend was lower or, at best, sideways. If you were trying to buy and hold a broad collection of US stocks, you would have been crushed in those markets.

That said, contrary to popular belief, some of the most dramatic rallies in stock market history occur during secular bear market phases. In many cases, these moves can produce triple digit gains and last for a year or more. A classic case in point: the recent rally off the March lows and the rally after the vicious 1973-74 recession.

Investors willing to follow cyclical moves in the economy and markets can make money even in a down tape. And I’m not talking about aggressive trading. Investors need not catch exact tops and bottoms but must be willing to take gains from time to time and buy when economic and market conditions are improving.

As I’ve often noted here and in Personal Finance, I’ve been bullish on the US market since last spring. Every month, I analyze one of my favorite quick indicators of the state of the US economy: the Conference Board’s Leading Economic Index (LEI), an indicator that’s composed of 10 constituent economic indicators. Here’s a look at the year-over-year change in LEI going back to 1970.

Source: Bloomberg

When the LEI year-over-year change crosses from above zero to below, it’s a good indication the US economy is entering recession. This simple rule “called” the US recession that began in late 2007 and was a stern warning that it was time to reduce exposure.

Similarly, the LEI began to show signs of life in the spring and crossed back above zero in midsummer. Although this does nothing to change the longer-term headwinds I describe above, it’s clear the US economy is experiencing a cyclical rebound that’s helped to push the averages to new highs this month.

Selectivity. During the secular bear market of the ’70s, gold, oil and other commodities performed well. In addition, some foreign markets, such as Japan, produced solid returns even as the US market marched in place.

Amid a secular bear market in the US, investors need to focus their attention overseas, particularly to developing markets like China and India. These markets rebounded from the global financial crisis of late 2008 much more quickly than the US, a sign that some foreign markets are beginning to de-couple from the US cycle.

My colleague Yiannis Mostrous notes in this week’s issue of Emerging Markets Speculator:

As expected China’s gross domestic product (GDP) posted solid growth in the third quarter, touching 9 percent. In the wake of this news, stories abounded about how the Chinese would likely raise interest rates to prevent the economy from overheating.

Investors should disregard these kneejerk stories; the National Bureau of Statistics of China recently released a statement reassuring investors that its monetary policy will remain accommodative.


As I’ve stated in the past, Chinese monetary authorities will target GDP growth of 8 to 9 percent next year; given lackluster growth in developed economies, the stimulus should remain in place. Any withdrawal of stimulus will occur gradually as the private sector picks up the slack, especially in the infrastructure area.

Domestic consumption and investment remain the driving forces behind China’s GDP growth, as exports were very weak. If exports to developed economies pick up in a meaningful way, then expect GDP to grow 9 percent next year.

My investment recommendations have targeted names that benefit from domestic growth, so I was encouraged to learn that per capita disposable income rose by 10.5 percent in the cities and 9.2 percent in the countryside.

Investing directly in China and India is one part of this selectivity strategy. But certain specific sectors and stocks in the US also benefit from growth abroad.

For example, energy commodities and related stocks are a big beneficiary of global growth in oil demand. From 1998 to 2008, oil demand from countries in the Organization for Economic Co-Operation and Development (OECD)--a proxy for the developed world--saw total demand growth of about 750,000 barrels a day (bbl/d). In contrast, non-OECD demand jumped by more than 10 million bbl/d.

That means the developing world drives more than 90 percent of global oil demand growth. This simple fact makes a mockery of those analysts who continue to focus solely on US oil demand and inventories as a predictor of global oil prices. And, as I recently wrote in The Energy Letter, the world faces severe oil supply constraints that will also help push prices higher in coming years.

You might also be surprised to find that US technology stocks are an excellent play on foreign growth as well. Of the 10 official S&P 500 economic sectors, Information Technology ranks near the top of the list in terms of generating revenues outside North America. Close to 55 percent of the sector’s revenues are derived from outside the region, and that proportion has been rising steadily in recent years.

Source: Bloomberg

This graphic shows the performance of the 10 US technology firms in the S&P 500 with the highest proportion of revenues from outside the US. The list includes such names as Texas Instruments (NYSE:TXN) and Intel (NASDAQ:INTC). As you can see, tech stocks with heavy foreign exposure have handily outperformed since the March lows.