Alpha Power Investing Newsletter

November 18, 2009

Winning In Secular Bear Markets

Many investors sense that there's something different this time. With two fierce bear markets in nine years, and with the S&P 500 still 30% below its 2000 high, something is going on that's not normal.

Actually, what's happening is perfectly normal. U.S. stocks are in a secular bear market, the fourth in the past 109 years.

A secular bear market is an extended time period, averaging about 17 years, when stocks generate low to negative returns. The last secular bear market began in 1966 and ended in 1982. Over that period, the S&P 500 and the Dow Industrials experienced four bear markets and ended at the same price levels as 1966. Adjusted for inflation, which was roaring during the period, the total return for stocks was deeply negative, and, in real terms, the break-even point didn't come until 1989 - 23 years after the 1966 peak.

To date, the S&P 500 is about dead-even (including dividends) in nominal terms for the past ten years. In real terms, the news is dismal - down 37.3%, or -3.5% per year.

The stock market from 1901 to 1921 is another example of this phenomenon. The Dow Industrials started at 75 in 1901 and in mid-1921 stood at - you guessed it - 75. Over that 20 year period there were five bear markets and war-time inflation.

Then, of course, there's the long bear market from 1929 to World War II - 12 years containing one 80% slide (lasting four years), one 50% slide, and one 30% slide. The bottom was hit about six months after Pearl Harbor.

Add it all up and you can see that U.S. stocks have been in secular bear markets about 50% of the time since 1900.

About the worst thing you can do as an investor during these periods is to own a lot of stocks and suffer through it. Of course, one of the main problems for investors is that they catch on late in the game and shift course just as things are about to improve. After the Depression, a whole generation of investors swore off the stock market forever.

That does not seem to be the case right now. If this secular bear market is average, we still have about seven years of trend-less, high volatility, go no-where gyrations ahead of us. Investors today are still hopeful that we are about to launch a new, robust bull market which will make them profitable once again. This hope flies in the face of the evidence - namely that long-lasting, robust bull markets begin when stocks are dirt cheap (under 10x earnings), not when valuations are above-average (as they are today).

The key to a profitable experience over the next seven to ten years is making gains and retaining them. This means buying and selling.

One of the most reliable gain-and-retain strategies is based on the annual forecasting cycle which "skews" stock returns into the period from late-October to early-May. The strategy of owing stocks only during this annual "power zone" and bonds the rest of the time has delivered excellent returns over the past decade. To see the result of this strategy using the Dow Industrials, the Russell 2000 and the S&P MidCap 400 indexes, go to the Power Indexing section of our website. As you will see, this strategy has worked for the past 60 years. A $1,000 investment in the Dow Industrial Average during the November to early-May period grew to over $82,000 from 1949 to year-end 2008. A $1,000 investment in the Dow from early-May to late-October (the "dead zone") shrank to about $600 over the same period. If that doesn't convince you that there's something structural going on which can be exploited for profit, nothing will.

The best index we've found for this strategy is the S&P MidCap 400. The mid-cap index is the best performing index over time and owning it only during the November to June time period, while holding intermediate treasury bonds the rest of the time, has produced positive returns for 27 of the past 28 years. Best of all, the returns are significantly higher than the index itself.

This strategy has also worked well throughout the current secular bear market. Since 2000, returns have been consistently positive (even in 2008). It's one of my favorite gain-and-retain strategies because it also works in secular bull markets with 40% less risk each year than the stock market.

The market is currently in the "power zone" so the odds are that stocks will be higher in May than they are today. After that, watch out - the "dead zone" of the mid-term election year is historically one of the most dangerous periods. Since 1900, the Dow has lost a total of 3200 points in the third quarter of the mid-term election year.

Jerry Minton, Ph.D.

© 2009 Alpha Investment Research Inc.
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