It is our belief that investors entered a secular bear market in 2000 which continues to this day – and may continue for several more years. Investors who have held fast to a passive buy and hold philosophy for the last eleven years are still way off their highs. The S&P 500 Index, as of September 1, 2011, is 21% lower than its high in March of 2000. If you invested $100,000 in the S&P 500 at the beginning of the last decade and followed the advice of the Buy and Hold crowd, your account would be worth roughly $79,000 today. This does not include the addition of dividends nor does it deduct fees and expenses that are present in actual investments.¹ The average dividend yield on the S&P 500 goes up as the price of the stocks in the index goes down and vice versa. The yield in the most recent decade has ranged from slightly over 1% in 2000 to 3% at the bottom of the market in 2009. Today it is yielding about 2%.
Secular bear periods and secular bull periods rotate in and out of favor, each lasting anywhere from a decade to 18 or 20 years. Secular in this context means era or long term period of years. You could call these extended periods “investing seasons” because of the pattern of rotation. Within each season, you experience shorter term bull and bear cycles or rallies and corrections. It is important for investors to correctly identify the “season” in order to determine the appropriate investment strategy and to control risk. While a buy and hold philosophy can work well in a secular bull market, it historically results in a lost decade or more in secular bear markets.
From 1982-2000 the DJIA average annual return compounded was 15.4%. During this eighteen-year secular bull market the general trend was positive and a buy and hold philosophy worked well. Investors accepted the stock market risk and volatility in the short term because they expected to profit in the long term.
During the period from 1966-1981 the DJIA average annual return compounded was negative -0.6%. This sixteen-year secular bear market was distinguished by volatile periods of double digit returns both positive and negative. Secular bear markets tend to be volatile. Rallies are followed by precipitous declines that take back all the gains. In this type of market investors need more active strategies instead of the general movement of the market. Active strategies are necessary in secular bear markets and risk management is of utmost importance for successful results.
What does a bear look like economically? Hindsight is necessary to accurately identify the beginning and end of these secular markets. However, history does give us some indication of what to look for. The beginning of a secular bear market is identified by:
- High P/E ratios – The P/E ratio on the S&P 500 at the peak of the technology bubble topped 40. By mid 2004 it had declined to 23, but that is still historically high. In the severe decline of 2008 and early 2009 it dropped to about 12. Today it is back up to 17. With a high P/E ratio at the outset of a bear cycle, you experience a declining P/E ratio through that period. A declining P/E ratio on the S&P 500 means that stock prices are declining. History shows that a declining P/E is more reflective of a bear market than a bull market.
- Low dividend yields – Low dividend yields are reflective of high stock valuations. At the beginning of this decade coming off the technology boom, the dividend yield on the S&P 500 was just over 1%. This is consistent with the beginning of other bear markets in the last century. As a result of the sharp stock market decline of 2008-2009, the yield on the S&P 500 rose to over 3% but now stock prices have increased and the average yield of the index, based on prices today, is about 2%.
- Low inflation – Stable prices or little to no inflation is generally good for financial markets. Moves in either direction historically signal the end of a bull market and the beginning of a bear market. Moves to either deflation or inflation cause a decline in P/E values which, as noted above, is consistent with a bear market. Inflation at historic lows means we are likely facing inflation in the future. Rising inflation is indicative of a secular bear market.
- Low interest rates – Like low inflation, low interest rates are also the friend of the stock market. But, as interest rates rise stock valuations decline and rising interest rates are more common during secular bear markets.
None of the economic characteristics that have supported long term bull markets in the past appear to be present in this decade. We believe that we entered a secular bear market in 2000 and eleven years later we continue in a long term bear market which could last several more years.
It does not mean that money cannot be made in this decade, but it does mean that different strategies are necessary. Investors must avoid the precipitous declines and the resulting losses that are common in the volatility of bear markets. Rather than rely on traditional asset allocation, investors need to consider alternative asset classes and be prepared to actively reduce equity exposure when supply takes control of the market. They must seize the opportunities that shorter term bull rallies present by investing in the strongest areas of the market. Secular bear markets require active strategies and continual oversight to avoid substantial loss.
Baby Boomers are too close to retirement to hold stocks through severe downturns like 2000-2002 and 2008-2009 and expect the market to recover their losses. It is critical to minimize losses rather than hold through them. Losses are costly and difficult to recover. As noted in the beginning of this report eleven years later, the S&P 500 Index is still down -21% from the top in early 2000. The traditional buy and hold approach has failed miserably since 2000. A pro-active money management approach is necessary in the current market environment.
¹Past performance may not be indicative of future results. Historical performance results for investment indexes and/or categories, generally do not reflect the deduction of transaction and/or custodial charges or the deduction of an investment management fee, the incurrence of which would have the effect of decreasing historical performance results.
