Investment Philosophy

It is our belief that investors entered a secular bear market in 2000 which continues to this day and may continue for a few more years.  Secular bear periods and secular bull periods historically 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 period of time.

You could call these extended periods “investing seasons” because of the pattern of rotation.  Within each season, investors experience shorter term bull and bear market cycles.  It is important to correctly identify the season in order to determine the appropriate investment strategy and control risk.

While a buy and hold strategy can work well in a secular bull market, it historically results in a lost decade or more in secular bear markets.  From 1982 to 2000 the Dow Jones Industrial Average annual average 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 stock market risk and volatility in the short term because they expected to profit in the long term.

During the period from 1966 to 1981 the Dow Jones Industrial Average annual average return compounded was a 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 most of the gains.  In this type of market investors need more active strategies.  Active management is necessary in secular bear markets and a strategy to manage risk is of utmost importance for successful results.

What does the economy look like in a secular bear market?  Hindsight is necessary to accurately identify the beginning and end of these secular cycles, 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 Price to Earnings (P/E) ratio on the S&P 500 at the peak of the technology bubble in 2000 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 12.  In June 2016 it is back up over 23 again.
    With a high P/E ratio at the outset of a bear cycle, the P/E ratio declines through the bear market period.  A declining P/E ratio on the S&P 500 means that stock valuations 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 2000 just coming off the technology boom the dividend yield on the S&P 500 was just over 1%.  This is consistent with the beginning of previous bear markets.  Following the sharp stock market decline of 2008-2009 the yield on the S&P 500 rose to over 3%.  As of July 2016 stock prices have increased and the average yield on the S&P 500 index is 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.  Moves to either deflation or inflation cause a decline in P/E values which, as noted above, is consistent with a bear market.   When inflation is at historic lows it means we will likely face inflation in the future and 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 appears to be present now.  We believe we entered a secular bear market in 2000 and sixteen years later we continue in a long term bear market.

It does not mean that money cannot be made in this environment, but it does mean that different strategies are necessary.  Investors must avoid the precipitous declines and the accompanying 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.  Investors must seize the opportunities that shorter term bull rallies present by investing in the strongest sectors 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.  A pro-active money management approach is necessary in the current market environment.

Past performance is not indicative of future results.  Historical performance of investment indexes does not reflect the deduction of transaction costs and custodian expenses or the deduction of an investment management fee, the incurrence of which decreases historical performance results. 
Written by Connie C. Guelich, CFP, AEP, CLU, ChFC.  This represents our view of the market at the time of this writing, July 15, 2016, and it is subject to change.  It is not intended to be personal investment advice.   If you would like to discuss your own account, please don’t hesitate to call us.  We are here to help and welcome your call.