Let me clearly state that I do not and, through 40 years of up and down cycles, never have subscribed to the above quote. That in fact is the gist of this article. But I am hearing those words, or words like them, from many clients, subscribers and commenters here on Seeking Alpha.
The other words I hear most frequently are, “We’ve never seen anything this bad before, Joe. We have Europe about to fall apart, our own country is slipping into Recession II, Wall Street is smarmier than ever, we’re too deep in debt to pull ourselves out,” and other such panic talk that we always seem to hear when people are about to throw in the towel.
“Throw in the towel” definition: A great time, having kept some powder dry, to pick and choose from among the very best companies then selling at bargain basement prices.
As to the headline quote, let me put it in perspective. It doesn’t come from anyone this year. Or last. In fact about half the population of the United States wasn’t even born when Institutional Investor quoted a leading economist who was telling everyone to throw in the towel -- in May 1970.
The economist was wrong. Since I entered the business, we have had our share of scary bear markets but we also enjoyed one of the longest booming bull markets in history, the 17 years that most of today’s investors cut their teeth on and thought they would never end. Then we had, more recently, a rather substantial rally from the depths of the dot-com-bom, a rally fueled by an insanely stupid pet social engineering project to provide home loans to people who couldn’t qualify for loans. Since these loans were guaranteed with Other People’s Money (yours and mine as taxpayers) who wouldn’t want to live in a nice house for free? For others not in this chosen group, anyone could get almost as good a deal by simply lying about their income, assets and employment. No bank bothered to check because, after all, these loans were guaranteed, without our knowledge, by thee and me.
And now that that particular government social engineering bubble has burst, they have had to create a new one, this time by giving your money and mine to brokers and bankers Too Stupid Too Succeed on their own and by penalizing retirees and savers by keeping interest rates so low that risk investing is the only alternative if they want to stay alive.
…which, of course, has led to the current situation where people say “We’ve never seen anything this bad before…” Except that we have. In the lifetime of many of us:
- 1929–1949: The Dow plunges to 41.22 on July 8, 1932, erasing 36 years of gains.
1967–1982: Welcome to stagflation. Shortly after the above economist’s quote in 1970, we enjoyed a 4-year mini up-cycle within the bear, then watched it double-dip down in 1974. Total decline: 45%
- 2000–2011, so far: The mini up-cycle just above 14,000 in 2005 doesn’t even surpass the inflation-adjusted 2000 high. By winter of 2009 we are at a 12½ year low just above 6,600. Total decline in those 18 months: 53%.
Here’s a different way of viewing it to determine if we’ve ever seen anything this bad. Click to enlarge:
(Original chart courtesy Sy Harding, streetsmartreport.com // notes in red, mine)
The astute observer will take away three key Investing Life Lessons from this chart:
(1) It has, too, been this bad before – and typically for more than just the 11 years we’ve endured so far!
(2) “This bad” isn’t all bad. Rather than move down, down, down in bear markets, we really move down, up, down, up, and these moves typically last at least a year or two of up and down cycle within the roughly 15-20 year secular major move. That means we can make money in a secular bear market in two ways: we can make it by being willing to go short as well as long or, if that’s too scary, we can go to cash when it’s ugly and still have a year or two of up-cycle every couple years. The only thing we can’t do in a secular bear is buy and hold.
(3) The geopolitical and economic situation has too been “this bad” before! Before this chart even begins, there was the Railroad Bubble in England where 25% of GDP in the 1840s went to laying more track than the nation could afford or need. As a percent of the US budget today, that would be $4 trillion. Somehow England went on to build an empire. In 1916, during the first bear market on the chart, Mexican forces under Pancho Villa rode across the US border to attack and murder United States citizens in Columbus, NM. A year later, the General dispatched to capture or kill Villa was leading US forces in World War I. I think a world war counts as “this bad.” The next period on the chart covers the Great Depression. We may be living under a black cloud today but those people lived under a black sky. 25% “official” unemployment was “this bad.” Finally, I cut my teeth in the industry on the 1967-1982 bear. It was this bad and worse.
The Big Lesson to be learned here? Markets come and go. Of course, it always looks to be the worst ever when it is happening to us, but in fact we’ve seen worse and come through it all. The Me Generation is so clichéd. Get over it.
You’ll also notice that the “bear markets” didn’t really give up a lot of ground. If you can afford to take a 60 or 100 year timeline, like Warren Buffett’s Berkshire Hathaway (NYSE:BRK.A) does as a corporate entity, you can buy and hold and, in any bull cycle, boast a really fine compound rate of return. Regrettably, most of us have a shorter time frame (as, indeed, does Mr. Buffett and his investments laid on in the past 10 or 15 years.)
Still, if you choose to hold through a secular bull and a secular bear (the long cycles), the secret is not to allow yourself to be panicked out at the bottom of one of the cyclical bear moves down (the shorter cycles that decline rapidly during the secular bear, but typically rebound for a year or more before tumbling anew.) That’s because you’ll note that these “secular bear markets” are really “consolidation markets.” They don’t go down so much as they go sideways. But the trendline for the markets over time – for more than a century – has clearly marched inexorably higher.
My job as a financial advisor, if I am doing it well, is to give unpopular and unwelcome reminders to my clients. Anybody can feed them happy talk, and will. It’s up to me to tell them no, we are not selling now that the market is down 3000 points, just because the talking heads are predicting more of the same; no, we are not buying now that the market is up 4000 points. Yes, we really are buying now that shares are cheap, even though all the headlines proclaim the end of the world; and yes, we really are selling now because markets do not grow to the sky.
So how does this affect our current situation – today? It is my humble opinion that we are still in a sideways / consolidation / “secular bear” cycle. Within that cycle, we are continuing to go sideways / consolidate / go nowhere, but we did enjoy an up move of 19% on the DJI in 2009 and 11% last year. This year – not so hot. We’re down around 4%.
My read of the short-term fundamental, value and sentiment indicators is that we are likely to see a decline for the next few weeks, anyway. (Among these are PE ratios, Price/Book Ratios, Price/Sales Ratios, the Dividend Yield on popular averages, what the Fed is doing, Mutual Fund Cash Flows, Put/Call Indicators, the success of Relative Momentum newsletters, Investment Advisor Sentiment and how much space stock market news gets in newspapers, radio and TV.) Like most declines within a secular bear, the odds are that it will be swift, vicious and scary. But about the time the last investor is ready to throw in the towel, which I imagine might occur as early as November, I think we will see a surprisingly good secular bear rally that will push the market closer to the top of the channel you see on the 110-year chart above.
If you agree with this scenario, that gives you two broad approaches to take: go into cash and equivalents or short the broad market and be ready and willing to place trailing stops as that side of the market begins to show fatigue with higher lows and higher highs. Using the indicators above, I first warned that all was not as rosy as it seemed on the surface back in mid-June (“Just How Sick is This Market?”) I have continued beating that drum over the last few weeks. If you read and agreed with our recent articles, you are already long the inverse ETFs RWM, SBB, SEF, EEV and/or SH. If you have not, I would suggest this is a fine universe from which to conduct your own due diligence to hedge your current holdings and protect the value of your portfolio.
I am not advocating selling all long positions; merely protecting what you have. If I’m right, you’ll be buying top quality companies like Statoil (NYSE:STO) Total (NYSE:TOT) Siemens (SI) Vale S.A. (NYSE:VALE) and ConocoPhillips (NYSE:COP) that I wrote our investment case for most recently here when their yields are higher, and their PEs and other value metrics are even lower – and you’ll be doing so with the dollars you saved by hedging your positions. If I’m wrong, you’ll have given up only a few weeks of opportunity.
The bottom line for me is that this is a bear market – but it isn’t “the way things will be from now on.” At 11 years of age, this secular bear is closer to the end than the beginning of its life. And if we can make a couple smart moves between now and its demise, we will have dollars available for what may be the first grand buying opportunity of this millennium!
Disclosure: We, and/or those clients for whom it is appropriate, are long SBB, RWM, SEF, SH and EEV. We are looking to sell puts to buy a number of fine companies as their prices decline, STO, TOT, SI, VALE, and COP among them.
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