We’re in what’s known as a secular bull market. That’s when the market continuously achieves new highs. A secular bear market is when the new market highs achieved seem to have a ceiling, blocking them from breaking out in a trend above the last high. In a bull market, the price at the end is higher than the price in the beginning. In a bear market, the price at the end is roughly level with the price at the beginning of the time period.
I normally discuss the stock market in terms of the S&P 500 index for my illustrations. This week I’m going to use the Dow Jones Industrial Average for my illustration specifically because I’m linking out to a piece that Guggenheim Investments updates every year. The Dow Jones Industrial Average is only made up of 30 companies. I’ve created this useful table for you so you can see the names of them. You should recognize all of them. I’ve linked the respective Google Finance page for each one to its name. So you can click the names to see more info or use the Google Finance interactive charts.
Here’s page 1 of the report so you can check it out. Click the image to download the pdf of the full report from Guggenheim.
What I’d like for you to notice about page 1 is the following:
- The history on this chart goes back 120 years.
- There are five secular bull markets and four secular bear markets.
- Out of the last 120 years, we’ve spent about 48 years in bull markets. Less than half the time in the entire history was spent in time periods where the market was consistently going up. We’re in one of those periods now.
- You could draw a straight line from point to point at the beginning and end of each bear market, but there are lots of jagged lines in those periods where every few years the market gives and then takes away about 40-60%. Imagine watching your investments go up for four years, only to see them go back down again.
Now let’s examine page two:
Here’s what I want you to notice on this page:
- It gives the length of time each market lasted in both months and years. The longest bear market started with the Great Depression and lasted 25 years. The longest bull market started in 1982 and lasted until 1999 and lasted a total of about 17 years.
- The last bull market, the one that ended in 1999, had a cumulative return of 1,059.31% from start to finish and an annualized return of 15.34%.
- The current bull market has the lowest standard deviation, meaning the market has less up and down movement and more movement in the up direction. You’ve heard me relay it this way before, and I’ll do it again for those of you who are new to Respire’s Insights. Think back to statistics class. Do you remember the bell curve? No? Okay. Imagine starting with a specific investment amount and ending with a different amount ten years later. Draw a straight line from point to point. Overlay the actual price history with all the ups and downs on top of your straight line. The greater the number and distance of data points away from that straight line, the higher your standard deviation. Basically.
- The bear markets all have approximately flat cumulative and annualized returns.
Here’s are the points I want you to take away from this Guggenheim chart:
We’re in a bull market right now and we never know we’re in a bull or bear market until we take a look back. Only hindsight is 20/20. I’ve been using this research piece for years to tell a story to my clients. It gets updated with data each year. The 2012 version of this was still showing us in a bear market, and it wasn’t until it was confirmed in a later year that the bear had ended back in 2011 that Guggenheim was able to update the piece.
Everyone is looking for a dip to buy but there might not be one for a while. The market could keep going up. That’s why I try to stay invested in at least a portion of an asset class until I have a confirmed sell signal. Or, in the case of the All Stock Growth at a Reasonable Price Strategy, I stay invested all the time.
When the much-anticipated dip arrives, it probably won’t be just one. It will probably be several spread out over a number of years. In my view, bear markets are actually major corrections. If you’ve ever taken science class and learned about thermodynamics, the way that prices of stocks rise and correct reminds me of heat transfer, temperature equilibrium, or a thermostat. Or, if you’re a biology person, think about the interaction between blood sugar and insulin.
We can determine a lot about the economy by the way the market is behaving. I’m always cautious. I try to communicate with all of you in a way that’s honest, not too alarmist, not too hyped. I invest based on rules so that I’m not just making educated guesses. You’ll regularly hear me say the market is overvalued or overbought. That’s true, but it doesn’t mean that it won’t keep going up. This earnings season has looked pretty good. Also, unemployment is very low. Just this week when I was updating the tactical asset allocation portfolios I noticed a stronger positive trend in the cyclical super sector which includes things like consumer discretionary companies and materials. That means the economy is doing well, it’s probably at it’s top, and people are spending money. I also noticed a slightly negative trend in the defensive super sector which includes things like consumer staples and utilities. These are things that perform better relative to cyclicals when the economy is in a slump because people always need cheese, peanut butter, toilet paper, soap, toothpaste, and electricity.
I’ve mentioned that when the market reaches this level investment managers know a lot of “irrational exuberance” is baked into it. We also know that what goes up must come down. So, I’ve talked about a correction and what it would look like: swift, fast, and deep. I also linked in one of my newsletters to one of Robert Shiller’s articles discussing a measure he uses that is far more effective than the 12 month price to earnings that novice investors use. In it he talked about how his indicator tells us that market valuations at present are higher than they were prior to historical bear markets. (Note that he uses a shorter term definition of bear market, different from a secular bear market.) CNN’s Fear and Greed Indicator has been consistently in the “Greed” territory. There are lots of things happening that would lead some investors to stay out of the markets for fear of a coming correction. If you have to retire in the next few years and you have all of your retirement saved that you’re going to need, then sure, maybe you want to talk to your advisor about reducing some of your stock exposure. You may have to forego upside, but at least you’d know you were going to mitigate some downside. But, for most investors, if you sell now there’s a very good chance you could miss out on upside. That’s why I never speculate. I keep my eyes wide open and watch, and I have rules for when I get in and out and what I buy.
Let’s talk about beating the markets. Can it be done? Sure, but anyone who does it consistently over all measurable time periods would be some sort of god, or time traveler, or psychic medium. Index investing has become popular because it’s cheap and we’re in a bull market. Index investing always becomes popular when that happens. Active investing, which costs more, always becomes more popular after people have been burned in a bear market. Do you want to invest the cheapest way possible and just match the market? It could be the best policy. But what happens if you enter a bear market that lasts 11, 17 or 25 years? That’s where a different strategy will serve you well. An asset allocation strategy might work out because you’d benefit from the upside of investments that move differently to stocks. That’s probably the easiest strategy. Or, maybe you find the dips and you only buy those, waiting years for them to come.
Let’s back up a paragraph. Do you remember that indicator I mentioned? The Shiller guy and the measure that becomes high before a bear market? He won the Nobel Prize in Economics, and in case you’re new to this, I dedicated the entire theme of a recent newsletter to him. If you checked out the article using the link in that other paragraph, you saw that he uses an indicator he calls the CAPE, Cyclically Adjusted Price-to-Earnings ratio. So, let’s only invest when the CAPE is low, right? Nope. That’s not the answer either. This guy decided to check out what would happen if you did that and found it was not an effective strategy. (Note: he’s also an investment manager. He’s a good one. But, come back here after you check it out if you follow the link.) I have no doubt that putting this together was tedious and he probably had more than one moment when he thought maybe he’d bit off more than he could chew. But he did it anyway. And, his results tell us that we’d have under performed the stock market if we’d followed the low CAPE principal. To summarize his results, he used the S&P 500 and the CAPE over two time periods. The first period he used was 1928 to 2016 and he found that just owning the index would have given him 9.53% annualized while only investing when the CAPE was below average would have given him 8.76%. Due to data related concerns, he decided to do the exercise using only the period from 1970 to 2008 and found that the spread was larger. The S&P 500 annualized 10.22% while a below average CAPE strategy annualized 7.92%. He then broke this down for another shorter period and had more pronounced findings that simply owning the index will outperform. The point is, buying only based on below average CAPE doesn’t pay off.
To illustrate the point further about picking and choosing when to participate in the market based on unknown market possibilities, this white paper from Invesco discusses missing the 10 best days and the 10 worst days of the market. It examines the S&P 500 from 1927 to 2016. If an investor participated the entire time and never sold, the cumulative return would be 12,470%. If an investor missed the 10 best days, they’d have a return of 4,093.57%. If an investor missed the 10 worst days, they’d have a return of 39,554.57%. It’s really important to miss the 10 worst days, but it’s also really important to make sure you don’t miss the best days. The other issue is that the best and worst days in the market often happen very close together. So, by avoiding the worst, you’d miss out on some of the best when the initial bounce takes place.
It’s all fun and games to participate in the market when it’s going straight up, and enjoy the returns of your index fund. But, that all changes when you ride the roller coaster of a secular bear market. There’s a choice that has to be made. That choice is whether or not you want to ride the roller coaster. You either have to expect to participate in it or avoid it. If you choose to avoid it, you’re not going to experience the same upside. If you choose to participate in it, you must have an iron stomach. It feels very different from the market right now.
There’s a happy medium that can exist when you employ an asset allocation strategy, or when you employ a tactical asset allocation strategy. A tactical asset allocation strategy follows specific rules that determine when and how much of each investment type to buy. It relies on real quantifiable existing data—evidence. What it isn’t: speculation. Periodically, the tactical rules any tactical strategist uses will miss the mark. A buy and sell will end up happening at the wrong time. Investors participate in a portion of the downside and miss a little upside. But, you can look at this like paying insurance premiums to miss the worst months of the market, instead of just the worst days.
What’s more important than investing based on how the market will behave, is investing based on how you will behave, and what’s appropriate for your goals. Remember what I said about someone who’s retiring in the next few years near the beginning of this post.
Other principles you should consider:
- Having realistic expectations.
- Realizing that investing is a marathon.
- Not letting emotions cloud your investing judgement.
- Applying a set of rules and standards that you use all the time, realizing that at times it may underperform and accepting that reality.
- Buying high quality investments and not expecting to win the lottery.
- Setting aside cash for short term liquidity. Keeping high interest rate debt to a minimum.
- Living within your means.
- Having a monk-like level of patience for your assets to grow and perform.
- Realizing there’s a tradeoff.
- Being aware of your own behaviors and managing them.
If you can do these things, then you can determine your desired level of participation and prioritize your tradeoffs. In the meantime, I’ll be keeping my eyes on my established rules that, for now, are allowing me to enjoy the continued upside of this bull market while the doom-and-gloom guys and gals sit on the sidelines and miss out.
