Secular & Cyclical Markets

Beware of the Secular Bear:

Bulls and bears rule the stock market. Everyday the talking heads on TV spew facts and figures as they discuss whether the market is headed higher or lower. It's almost comical as different analysts throughout the day contradict one another as they attempt to forecast the general direction of the stock market. The truth is; each analyst has his or her own investment agenda as well as time horizon (short, intermediate, or long-term) making it difficult for investors to gain any real market insight from a quick three minute interview.

In this issue of Investor Notes we will focus on the facts as we discuss the differences between longer-term secular and intermediate-term cyclical bull/bear markets. A detailed overview of these market types will provide investors with an historic perspective on where the markets have been and where they are likely headed. Once investors have perspective on the U.S. equity markets they will be in a better position to properly construct their portfolio for what ever may lay ahead.

The Secular Bear:

There are bear markets and then there are BEAR markets. How investors position their portfolios is vastly different when confronted with a cyclical bear versus a secular bear market. We have compiled a great deal of information to make the case that U.S. equity markets are now in a secular bear market and have been so since early 2000. If we are in fact in a secular bear market then investors a) need to further diversify their portfolio with additional asset classes such as managed futures and b) need to follow an investment strategy that is actively managed to take advantage of trading situations. The old long-term buy-and-hold strategy employed by many investors in the 80s and 90s is ill-equipped for the volatile and sideways action of a true secular bear market.

Let's take a closer look at the markets over the years to provide investors with some much needed historical perspective. The secular menu below will help you navigate this Investor Note article.

Secular Menu:
Secular and Cyclical Introduction
Where are We Now?
Long-term Secular Market Overview
The Case for a Secular Bear
Secular/Cyclical Market Definitions

Secular and Cyclical Market Introduction:

Let's begin with some basic definitions. A secular market refers to the primary trend in any given market. As an example within the last 70+ years the Dow Jones Industrial Average has experienced two secular bull markets and two secular bear markets. During these secular markets each has experienced several countertrend markets or cyclical markets. The recent secular bull market (1982 - early 2000), encountered several periods that can be termed as cyclical bear markets; October 1987 Crash, July 1990 Gulf War, and April 1998 Russian default. Yet at the conclusion of each of these cyclical bear markets, the primary secular bullish trend was reestablished allowing the market to move to higher levels.

Secular bear markets work in the same fashion but in the opposite direction. The countertrend or cyclical markets are bullish in nature providing investors with strong periods with an upside bias. But these periods are short lived before the secular bear market reasserts its longer-term downward trend.

The charts below illustrate the performance of each of the four secular markets experienced by the Dow Jones since 1929. A link to a detailed description of each secular market is available in the "Quick Links" (shown above/right) or in the "Market Highlight" area beneath Charts 1 and 2.

1929 - 1949 Secular Bear Market Highlights: Total duration 19.83 yrs. Percentage loss (56.0%). Annual ROR (4.06%). 7 Cyclical bull/bear phases. Click for a complete overview of the 1929 - 1949 secular bear market.	1949 - 1966 Secular Bull Market Highlights: Total duration 16.58 yrs. Percentage gain 488.6%. Annual ROR 11.28%. 9 Cyclical bull/bear phases. Click for a complete overview of the 1949 - 1966 secular bull market.

1966 - 1982 Secular Bear Market Highlights: Total duration 16.50 yrs. Percentage loss (17.8%). Annual ROR (1.18%). 9 Cyclical bull/bear phases. Click for a complete overview of the 1966 - 1982 secular bear market.	1982 - 1999 Secular Bull Market Highlights: Total duration 17.42 yrs. Percentage gain 1,322.9%. Annual ROR 16.38%. 7 Cyclical bull/bear phases. Click for a complete overview of the 1982 - 1999 secular bull market.

Table 1: Secular Market Overview:

The turning points used to define the secular/cyclical markets are based on the academic work of Gonzalez, Powell, and Shi in their report Defining and Dating Bull and Bear Markets: Two Centuries of Evidence.

Basic secular market observations:

• Secular markets definitely differ from cyclical markets from a time perspective. The duration of each secular market can last for 8 - 20 years.
  
• Secular markets alternate from bullish to bearish and back again.
  
• Secular bull markets can be extremely strong and profitable. A passive buy-and-hold strategies may work well during these secular bullish periods.
  
• Secular bear markets may take on two possible forms. The first is a massive decline followed by a slow recovery. An example of this type of secular bear market would be the 1929 - 1949 market experienced in U.S. equities. The second secular bear market style falls into the volatile sideways trading range category. The 1966 - 1982 secular bear market fits this format. An active well-diversified trading strategy should work well during these secular bearish periods.
  

Where are we now?

There are two schools of thought on whether we remain in a secular bull market or are currently in a new secular bear market.

1. Wall Street's equity cheerleaders of the 90s, still cling to the notion that we are in a secular bull market. They suggest that since the markets top in early 2000 we have been in the midst of an above average cyclical bear phase in both severity and magnitude. They suggest that the cyclical low set in September 2002 ended the bear phase and the secular bull that began in 1982 is still in tact.

On the other hand . . .

2. Many analysts have concluded that the secular bull market spanning 17+ years (Jun 82 - Dec 99) did in fact end. History suggests that we are in a new secular bear market and the true correction has just begun at least in terms of time. At LexAm we believe that we have entered into a secular bear market that will most likely last for the foreseeable future. The question that investors should be asking is not if we are in a secular bear market but rather what type of secular bear market are we in?

Based on the two most recent secular bear markets; should investors expect a volatile 1929 - 1949 bear market or a trading range 1966 - 1982 bear market. Time will tell. We can however make two suggestions for investors; diversify your assets and actively manage your investment portfolio with the help of professionals. The buy-and-hold strategy used by passive investors in the last secular bull will most likely struggle in the current secular bear market.

Click to view the current Dow Jones secular market covering the 1999 - Present period.

The Case for a Secular Bear:

Why are we in a secular bear market and how long will it last? John Mauldin has provided a chapter from is new book that helps to answer these questions. His writings centers on secular bear markets and is available to download in a PDF format. For those truly interested in learning more about extended bear markets this is a must read.

Click to download "The Case for a Secular Bear Market" written by John Mauldin.

Long-term Secular Market Overview:

Secular bull and bear markets are not a recent occurrence. In fact according to Mike Alexander, author of Stock Cycles, there have been a total of 14 secular markets since the nineteenth century . Table 1 outlines the seven secular bear and seven secular bull markets that have occurred in the S&P 500 Index since 1802. The duration of these secular markets range in time from 8 - 20 years. As a point of reference, the average secular bull market lasts for 14.71 years while the average duration for a secular bear market is 13.57 years.

Secular markets are long-term by nature, therefore investors need to correctly position themselves to either a) take full advantage of bull phases and b) properly diversify during bear phases. >>> Click here for more information on these long-term bull/bear markets as outlined in Mike Alexanders' Secular Trends article.

Table 1: Secular Markets Overtime Based on the S&P Composite Index.

Secular/Cyclical Market Definitions: