Within the Vice-like Grip of the Secular Bear

The Labor Department released the August jobs report last Friday.  The median estimate of economists surveyed by Bloomberg was for a gain of 130,000 jobs.  The actual number of new jobs created was just 96,000.

This means several things.  First it means the estimates of expert economists were off by 35 percent.  Naturally, it must be nice to work in a profession where it’s perfectly acceptable to miss the mark by 35 percent.  No doubt, in most professions, missing the mark by 35 percent will severely impact one’s performance review.

The other thing the dismal jobs report means is that Wall Street’s expectation for more quantitative easing will now reach a fever pitch.  Don’t you know?  In this upside down world of monetary folderol, bad news for the economy is good news for stocks.  For this may just be the dreary data Fed Chairman Ben Bernanke needs to initiate a program of open ended Treasury purchases.

Here at the Economic Prism we believe Bernanke’s hands are tied for the moment.  What we mean is, although he may be a madman, he’s not a complete idiot.  How could he possibly pump new money into the credit market when stocks are approaching all-time highs, oil’s at 96 per barrel, and gold’s above $1,700 an ounce?  Are not these blatant examples that there’s already too much credit based money floating prices higher?

Bernanke’s always waited for prices to break prior to previous QE experiments.  Nonetheless, despite our belief that Bernanke’s not a complete idiot, there’s still the possibility he could prove us wrong.  This Thursday, following the Federal Open Market Committee Meeting, we’ll find out if the man’s mind has gone soft.

The Secular Bear

Regardless, even if Bernanke does announce QE3, this will be a classic ‘buy the rumor, sell the news’ event.  The S&P 500’s spiked up nearly 12 percent since June 1, despite lackluster earnings.  Obviously, the increase has been in anticipation of QE3.  Hence, if Bernanke actually makes the big announcement Thursday look for stocks to run up for a day or two before falling on their face.

According to Albert Edwards of Societe Generale, stocks are in for a long winter…

“I believe that the third leg of the Ice Age de-rating in equity markets is imminent.  For this secular bear market to end, investors must voluntarily give up hope.  Otherwise the vice-like grip of the bear will soon squeeze the hope from their gasping, broken bodies,” wrote Edwards in a note to investors.

Of course, the secular bear market Edwards is referring to is the bear market in stocks that commenced in early 2000.  On March 24, 2000, the S&P 500 closed above 1,527.  That was before it crashed nearly 50 percent to 776 on October 9, 2007.  From there the S&P 500 advanced to a peak of 1,565, a new nominal high, before crashing 56 percent to 676 on March 9, 2009.

Looking back at past secular bear markets, the current bear market will, at a minimum, trend sideways for another 5-years…there’s also the possibility another 50-percent crash will occur before the next secular bull market begins.

The word “secular”, when used to describe markets, has nothing to do with religion.  It’s derived from the Latin word saeculum, which is the word for an “era” or an extended period of time.  Looking back at the S&P 500, the stock market waltzes along secular bull and bear market cycles.

In a secular bull market, strong investor sentiment drives prices higher, as there are more net buyers than sellers.  While in a secular bear market, weak investor sentiment causes selling pressure over an extended period of time.  Ignoring these secular market cycles, which is what the ‘buy-and-hold’ investment strategy does, is devastating to one’s wealth.

Within the Vice-like Grip of the Secular Bear

If you stare at a historic price chart of the S&P 500 for long enough, you’ll notice that secular market cycles generally last between 15 and 20 years.  You’ll also notice they do not move perfectly upward or downward.  For instance, a secular bull market will have bear market periods, called cyclical bear markets.  However, these cyclical bear market periods will not reverse the overlying trend of upward stock prices.

Similarly, a secular bear market will have cyclical bull market rallies (like right now), yet these cyclical bull market rallies will not overcome the larger secular bear market trend.  For example, the S&P 500 was in a secular bull market from 1982 to 2000 even though the stock market passed through a cyclical bear market in 1987.  The losses from that bear market period were quickly recovered and the S&P 500 continued on its secular bull market trend for another 13 years.

Secular bear market cycles often don’t include nominal losses.  Sometimes the market appears to be flat, or trend sideways.  However, in real – inflation adjusted – terms, losses are significant.  During the 1966 to 1982 secular bear market, for instance, there were hardly any nominal losses.  But, due to inflation, during that time the dollar lost 66 percent of its value.

Likewise, during the secular bear market that began in 2000, for a brief time during 2007 it appeared the market had recovered its losses – even gaining a little.  But, when adjusting for inflation, real returns were down; the dollar lost 21 percent of its value during that time.  What’s important to recognize from this is that real secular bear market losses are often masked by inflation.  Thus, nominal stock market prices appear to trend sideways, when – in real inflation adjusted terms – they are down significantly.

At the moment, there’s likely about six more years to go in the current secular bear market.  We don’t like it.  We look forward to the days when we can dollar cost average into an Index 500 fund and watch it go up 10 percent a year, year after year.  Yet before that, as Edwards noted, “investors must voluntarily give up hope.  Otherwise the vice-like grip of the bear will soon squeeze the hope from their gasping, broken bodies.”

Obviously, voluntarily giving up hope, rather than having it squeezed from your gasping broken body, is the more desirable route to take.  Fortunately, if you have the foresight to take it, the recent rise in stock prices provides an ideal off ramp to exit the market from.

Sincerely,

MN Gordon
for Economic Prism

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