The idea that we are currently in a bear market is absolutely ludicrous. At least it is at first glance. After all, stocks (SPY) have gained +177% since early March 2009 lows and finished Wednesday with the S&P 500 closing at a fresh new all-time high. Make no mistake; we are currently in the midst of a still raging and absolutely relentless cyclical bull market. But despite all of the stock market glory over the last five years, this cyclical bull market is still taking place in an ongoing secular bear market that began at the turn of the millennium thirteen years ago.
Absurd you might say. How can we possibly still be talking about us still being in a secular bear market in 2014 when the stock market is now trading roughly +20% above its previous all-time highs from March 2000 and October 2007?
The following are four reasons we are still in a secular bear market.
1. Secular bear markets last a lot longer than 9 years
Secular market cycles occur over long-term periods of time. Why do they occur? Put simply, as the economy and financial markets go through extended periods of sustained expansion known as secular bull markets just as they did from 1921 to 1929, from 1949 to 1968 and from 1982 to 2000, they accumulate various excesses including increasingly misallocated capital, lax regulations as well as too much leverage and debt. The economy and markets eventually overheat and enter into extended secular bear market periods where the excesses from the past secular bull market are worked off and consolidated. This is what took place from 1901 to 1921, from 1929 to 1949 and from 1968 to 1982. And it is what is continuing to take place today.
These secular market phases take 17 years on average to play out. If the latest secular bear market did indeed end with the market bottom in March 2009, it would represent the shortest secular bear market in history by nearly one-half. Perhaps this is true, but it is unlikely for the following reason.
2. Secular bears do not go away with coddling; they require taking medicine and enduring pain
A secular bear market comes to an end once the economy and markets have fully cleansed their excesses. The secular bear market came to an end in 1921 when policy makers allowed the post WWI depression to play out with the Fed largely standing aside and fiscal policy makers cutting government spending, reducing the national debt and lowering tax rates. The secular bear market that sparked the Great Depression finally came to a conclusion following the end of World War II and the difficult post war adjustment to a peacetime economy that followed. And the secular bear market from 1968 to 1982 came to an uncharacteristically early end at just 15 years once Fed Chairman Paul Volcker took a hatchet to the inflation crisis by raising interest rates as high as 20% and plunging the economy into recession as a result. In each instance, the economy and markets were forced to endure pain and medicine to finally bring the secular bear market to an end.
The policy approach to today's secular bear market stands in sharp contrast. Following the bursting of the tech bubble from 2000 to 2002, government spending increased and the Fed slashed interest rates to 1%, which helped to inflate the housing bubble. Once the housing bubble burst from 2007 to 2009, fiscal policy makers entered into the largest government spending program in U.S. history and the Fed not only lowered interest rates to 0% but quintupled the size of its balance sheet to date through three rounds of quantitative easing. But despite all of this coddling, we have little more to show for it today other than an economy that was pulled back from the brink onto a anemically sluggish growth trajectory, historically high and rising government debt, a stock market that while at all-time highs has produced no measurable wealth effect to support growth and a revival of many of the inappropriate bubble inflating behaviors that led us to the previous two market crashes in 2000 and 2007. If you don't believe me on this final point, then take a look at the latest commentary from Dallas Fed President Richard Fisher, who will be at the Federal Open Market Committee table casting his votes on monetary policy in 2014.
Until policy makers turn into the problem and allow the accumulated excesses to finally be cleansed from the economy and markets, the secular bear market will remain ongoing. And we will know that this process has fully taken place only when the next two conditions are met.
3. Valuations have yet to reach trough levels
By the end of the three preceding secular bear markets, stock valuations as measured by the 12-month trailing price-to-earnings ratio had declined into the high single digits and lingered in this range for an extended period of time. During the latest secular bear market that began in 2000, stocks spent a moment with valuations just below the long-term average at the crisis bottom in March 2009 before launching back higher. And today, they remain at levels toward the high end of the historical range.
Of course, the final point helps explain why valuations still remain rich so many years after the start of the latest secular bear market.
4. Investors are still in love with stocks
At the end of past secular bear markets, investors hated stocks. Many that lived through the experience of the Great Depression and the markets at the time swore they would never buy stocks again, and a large number actually stuck with this promise to the end. And the investor sentiment toward stocks at the end of the secular bear market in the late 1970s and early 1980s was represented well by the now famous "The Death of Equities" article. While many investors are understandably skeptical about stocks today after having been twice burned since 2000, they remain the most favored asset class that continues to receive a dramatically disproportionate share of media coverage and investor attention. Until we have arrived at the point where investors have come to fully disdain the idea of owning stocks and no longer wish to hear about them, the secular bear market will drag on.
But with all of this being said, how can we possibly still be mired in a secular bear market with stocks having rallied so strongly in recent years and now trading at all-time highs? This is simply part of the fundamental nature of secular bear markets.
While a secular bull market implies that stocks are steadily rising, a secular bear market does not mean that stocks are steadily falling. Instead, what characterizes a secular bear market is that stocks swing wildly higher and lower in a sideways pattern for an extended period of time. And revisiting the chart at the beginning of this article, sideways swings completely define how the market has traveled since its March 2000 peaks. It has endured massive crashes with losses of more than -50%. And it has enjoyed incredible rallies in the +100% to +200% range. Such is the behavior of all secular bear markets. For example, the stock market rallied by +370% over five years from 1932 to 1937, but this did not mean that the secular bear market was over, as it went on to decline by -52% over the subsequent five years through 1942. And while the magnitude of the advances and declines were a bit more muted during the inflation driven secular bear market of the 1970s, it was marked by numerous multi-year advances in the +60% to +75% range followed by corrections in the -30% to -50% range before finally coming to an end.
This raises a key point about secular bear markets. Investors should not avoid owning stocks during these extended phases. To the contrary, there will be times when investors should back up the truck and buy shares hand over fist. But such buying sprees should be kept for when stocks have corrected and are trading toward the lower end of its trading range. And as stocks rise toward the top end of the range, share ownership should become increasingly selective as the next corrective phase becomes imminent.
Such is where investors find themselves today. We are not only at the top end of the current secular bear market trading range, we are now +20% beyond it thanks to the persistent generosity of policy makers at the U.S. Federal Reserve. While it has been an intoxicating ride higher for stocks over the last few years, this policy support is now in the process of being finally unwound with the scaling back of Fed asset purchases as part of QE3 expected to continue in the coming months. While this does not mean that investors should abandon the stock market, particularly as long as momentum remains firmly in tact to the upside, it at least suggests investors should exercise caution in managing their stock portfolios as we continue forward into 2014. They might even be well served to begin considering opportunities outside of the U.S. stock market that may offer more attractive upside in the coming year and beyond.
Disclosure: This article is for information purposes only. There are risks involved with investing including loss of principal. Gerring Capital Partners makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made. There is no guarantee that the goals of the strategies discussed by Gerring Capital Partners will be met.
Additional disclosure: I am long the stock market via SPLV and XLU along with selected individual stocks.