When Will The Bull Market Return?
FORECASTS & TRENDS E-LETTER
IN THIS ISSUE:
1. David Henry On A New Bull Market
2. Why Wall Street Needs A New Bull
3. Make Half A Decision
This week, I am off spending some time with my son, who is home from college for Spring Break. Since we live on the lake, I’m putting in a lot of time driving the boat while he and his friends ski and wakeboard on Lake Travis. It’s a tough job but somebody’s got to do it.
Since I’m out most of the week, I have chosen to reprint below a very informative analysis on the history of bear markets in stocks, and what it might take to turn the one we’re in around. This article originally appeared in Yahoo! News and I thought the author, David Henry, had some good insights into how stock market cycles work.
Last week, many market analysts were pleased to see a consecutive string of positive days in the stock market. Of course, this immediately sent some in the financial media into a frenzy about how we have now seen the bottom of the bear market and we can only go up from here. It seems that there is no shortage of cheerleaders for a renewed bull market. If wishing could make it so, we’d definitely have an up market from here on out. But for now, I remain unconvinced.
That being the case, I follow David Henry’s reprint with a discussion about why we often see so much attention being given to a return of the bull market. Obviously, everyone from investors to the government wants the market to go up since it’s supposedly a sign of a healthy economy. But as we all know, our economy and financial system are far from healthy at this point, so it remains to be seen if the bear market is over.
The last two bear markets in US stocks have underscored the weaknesses of the widespread “buy-and-hold” investment strategies that have been Wall Street’s mantra for decades. The bottom line, in my opinion, is that when you offer buy-and-hold investment products that only work in up markets, you root for a bull whenever you can.
I’ll end up the E-Letter by discussing a way for you to include active management investment strategies that may be more comfortable for you. Sometimes, making “half a decision” can help you to test the waters of active management, while still having a foothold in other investment strategies that may be more familiar to you. Let’s get started.
Stock Markets: When Will the Bull Return?
The stock market is crashing -- slowly, and in plain view of the people who count on it most. The 53% plunge in the Dow Jones industrials since October 2007 [measured as of March 6th – GDH] has wrecked the college- and retirement-savings plans of millions of investors. It has permanently lowered the long-term investment projections of private endowments and pension funds. It has sent corporate compensation experts scrambling to figure out how to reward top employees. All told, more than $10 trillion of stock market wealth has vanished, and with it the confidence that springs from financial security.
While 17 months may feel like an eternity, it could turn out merely to be a prequel. The questions on the minds of investors, money managers, and corporate executives are threefold: How much longer will the bear market last? How low will the averages go? And when might investors get their money back?
As Warren E. Buffett has said: "Beware of geeks bearing formulas." It's especially difficult to predict the direction of the markets these days because the most popular gauges, from price-earnings ratios to measures of investor "capitulation," have stopped working. The peculiar nature of this bear market limits the kit of useful tools to just a handful of bond market and business confidence indicators.
Those signals, along with interviews with financial historians, market strategists, and economists, point mostly to painful scenarios. Stocks don't seem likely to fall much more from here -- but market turmoil could continue for months or even years. Worse, by the time the market revisits its highs, so many years are likely to have passed that many older people will have gotten out of stocks, missing out on the rebound. The flip side is that new money put into the stock market now will likely do comparatively well over the long term. That's welcome news for twentysomethings and executive compensation consultants, but perhaps not for soon-to-be retirees.
Searching For Precedents
History can't provide as many clues to the market's direction as usual. That's because while most bear markets more or less track the business cycle, this one began with a broken financial system. That makes the current bear more like the one that snarled from 1929-32 than others of the past 100 years. But that analogy doesn't fit perfectly, either. "We have no good precedents to help us," says Peter L. Bernstein, a 90-year-old market essayist and financial historian who was a teenager during the Great Depression. "What's breathtaking is the rapidity of the decline and its breadth."
The market anxiety is especially high now because of the raging fire in the economy. "The next six to nine months are going to be awful," says Desmond Lachman of the American Enterprise Institute. Waves of corporate defaults, home foreclosures, bank failures, and job losses are still to come.
Of course, the stock market already knows that for the rest of 2009 the economy will be a "shambles," to use Buffett's recent description. Today's low share prices may well reflect that. The Dow Jones industrial average has already fallen through the 7,000 level predicted earlier this year by Nouriel Roubini, the New York University economist nicknamed “Dr. Doom” for daring in 2006 to foretell the credit calamity. That's right, even Dr. Doom was too optimistic.
If recent history were a reliable guide, it would be just about time for the bear to retreat to his den, which nowadays might include a flat-panel TV and leather chair bought at a foreclosure sale. The market's average decline during bear markets since the 1929 market crash is just 30%. What's more, those past bears lasted an average of 13 months, making this one look not just mean but old.
But this is no ordinary slump. Even the most basic market gauge, the price-earnings ratio, which measures a company's share price relative to the earnings it generates, is unreliable. Historically, the overall market has traded at prices that average 15 times earnings, ranging from roughly 8 during the worst bear markets to 25 or greater during bull runs. At the start of the year, the market's p-e ratio was about 11, suggesting that stocks were already cheap and wouldn't drop much more. Instead, the Standard & Poor's 500-stock index fell 19% in January and February, the worst opening months on record.
Why did the p-e ratio get it so wrong? The "e" is plunging -- by 18% in January and February alone, according to Thomson Reuters. As a result, even though the stock market has dropped, it hasn't gotten any cheaper relative to earnings. Sure, a lot of earnings vanished amid a fog of one-time charges that may say nothing about companies' future profit power. But analysts still aren't seeing through that fog; their earnings projections are more scattered than they've been in two decades. "You don't know what the 'e' is because the economy is in free fall," says Charles Biderman, CEO of TrimTabs Investment Research.
The credit bust has rendered other trusted market indicators useless -- most notably monetary policy, or the Federal Reserve's raising or lowering of its benchmark interest rate. Before the current slump, the federal funds rate was a reliable indicator in all but one bear market since World War II, says James B. Stack, president of InvesTech Research and Stack Financial Management. When the economy slowed, the Fed began cutting rates to turn the business cycle back up. After the second cut came, investors stepped in to buy, anticipating higher corporate earnings. But the Fed has cut rates 10 times since August 2007, to essentially zero, and yet the economy and stock market keep sliding. "The Depression is the only parallel for the lack of effectiveness in monetary policy," says Stack. It is failing because too many borrowers don't want to borrow and too many lenders don't have the capital or courage to lend.
Measures of capitulation, Wall Street's term for the final moment of a sell-off when the last weak investors give up on stocks, aren't working, either. The idea is that once the wobbly players are out, the ones left are strong enough to bid up stocks. Bull runs begin during those moments. Market mavens try to track capitulation by parsing statistics from days of heavy selling and comparing the intensity of past routs. Many thought they saw capitulation last September, says Eric C. Bjorgen, senior analyst with the Leuthold Group in Minneapolis. "But then the market kept going down," says Bjorgen. "Extreme fear was not a good indicator." The gauges became even more bullish with the selling in November, after which the market rallied 24%. Then it fell again. Biderman of TrimTabs says that's because much of the selling was by hedge funds that had been using borrowed money, not a major factor in previous bear markets.
Another signal that's turned out to be misleading is "cash on the sidelines," or the funds in money market and bank savings accounts. In normal times, strategists could look with some confidence to money in these accounts as buying power that investors were holding back from the stock market. The greater the cash compared with the value of the overall market, the more impact it could make on stocks. In January the reading reached its highest levels since 1984, says Bjorgen. Even so, he's dubious. As long as investors are worried about their own incomes, he says, the money seems most likely to stay right where it is. TrimTabs' Biderman, who tracks how investors move their money among asset classes, says he doesn't see much chance of this cash flowing into stocks with the job and housing markets so weak. He figures investors have been taking more money out of stocks than they've been putting into their cash accounts. "Some people are being forced to sell stocks to eat," Biderman says. "They are certainly not going to buy Google here."
With the ordinary historical measures failing, experts are looking further back for clues. During the Great Depression, the Dow plunged 89% from the 1929 crash to July 1932. Then it went through some big swings before losing 49% in 1937-38 as the economy tanked again. World War II, which grew in part out of financial stress around the globe, followed. The Dow didn't get back to its 1929 high until 1954.
Much, of course, has changed in the U.S. since the Great Crash. Back then Washington made major policy mistakes, such as erecting trade barriers and letting too many banks fail without protecting depositors. This time, with a couple of exceptions, the government hasn't blundered so, even though it hasn't yet solved the economy's many problems.
So this bear market likely won't rival that of the Great Depression. But the bear markets during other banking crises have been brutal in their own right. In a recent study of 21 such episodes from around the world, including ones from Spain in 1977, Sweden in 1991, and Thailand in 1997, professors Carmen M. Reinhart of the University of Maryland and Kenneth S. Rogoff of Harvard University found that stocks fell an average of 56% -- the same loss the S&P 500 had suffered through Mar. 3. Those bear markets also tended to be agonizingly slow, taking an average of 3.4 years to reach bottom. "Everything is protracted," says Reinhart. "In the best-case scenario, you are looking at six years or longer" to return to past highs. Bad as that sounds, it would compare favorably with Japan, whose Nikkei index reached 38,900 in 1989 and now trades at around 7,200.
Of course, just because investors have lost money in stocks doesn't mean equities are a bad choice from this point onward. "Stocks can't make up for the past 10 years, but they can do extremely well from our current position," says Jeremy J. Siegel, author of Stocks for the Long Run and professor at the Wharton School of the University of Pennsylvania. Siegel says that while stock returns have fallen behind government bond returns over the past 20 years, history says that's almost certain to reverse. He's found only one 30-year period when stocks returned less than bonds, and that one ended in 1861. "That tells us that once you are down 50%, those who are in stock markets for 10 to 15 years will get much better returns," he says. Lately, government bond prices have run up, boosting the odds that stocks will be the better play in the future.
So where to look for signs of an incipient upturn? One logical place is the corporate debt market, which understands the economy's core problem firsthand. Eventually, the pace of new defaults on corporate bonds will slow, and bad debts will be reduced or erased in financial reorganizations and bankruptcies. When those things happen, the economy and stock market should breathe easier…
Another critical factor is the health of the banking system. One measure to watch is banks' so-called net worth, or the difference between how much they owe and the value of their assets. Rebuilding the banking system's net worth will be monumentally difficult. "On average, this process takes about six years," says Joseph Mason, a banking professor at Louisiana State University who has studied past banking crises. So far, little has been accomplished -- a big reason the stock market hasn't gotten up from its knees.
Keep An Eye On CEOs
Government policy decisions could speed or slow the pace of rehabilitation for the banks and, in turn, the stock market. David A. Hendler, a New York-based bank analyst at CreditSights, says his job has shifted from financial analysis toward Washington analysis. Essentially, his task is to figure out how quickly the government will permit weak banks to consolidate. When investors believe they know which banks will survive, they'll buy their stocks. The process is so critical to the stock market that Richard Bernstein, chief investment strategist at Merrill Lynch, is tracking six signposts for financial industry consolidation. Among them: the extent to which the government carves up and sells bad banks rather than buying into them to prop them up.
Other strategists are keeping a close eye on the people who really know what's happening in the economy: business leaders. Biderman says he'll know corporations are getting confident once they start buying back their own shares and acquiring other companies. Right now they show no such bravado. Announcements of share buybacks are down 90% from a year ago, leaving that market thermometer so cold the mercury is off the scale.
In the end, the timing of the bear's retreat will likely hinge on that great market imponderable: psychology. How investors feel has a lot to do with whether they start seeing mixed signals as proof of a glass half-full. "The (market) stress causes the analytical part of our brains to shut down, and that makes us hyperreactive to bad news," says Michael A. Ervolini, CEO of Cabot Research, a consultancy catering to institutional investors. People become convinced conditions are worse than rock-bottom bad, he says. Only after they see that they've overreacted can things improve: "We look for the market to start (saying) tomorrow will be brighter."
For now, pessimism is winning the day. In the worst-case scenario, bad debts will continue to weigh on borrowers and lenders, causing the economy to slow even more, which will erode incomes and push more borrowers over the edge. Economies and corporations around the globe will weaken and rattle investors and business executives even more. Such fears have prompted Ben McCoy, a 30-year-old software engineer, to swear off new stock investments. Instead, he's putting money into his own business ventures, such as writing software for real estate appraisers and a blog about personal finance called moneysmartlife.com. "With these investments, I feel like I have more control," he says.
More Ben McCoys could signal the stirrings of an upturn. A market bottom, says Merrill's Bernstein, "generally occurs when everyone thinks it will never happen. You want to hear people giving up on the stocks-for-the-long-run theme."
But something positive must draw investors back. George A. Akerlof, a Nobel prize-winning economist at the University of California at Berkeley and co-author of a new book, with Yale professor Robert J. Shiller, on the importance of sentiment in moving markets, says investors will have to be offered a new story they can believe to get them to buy again.
That new story likely involves corporate and consumer debts being reduced to what borrowers can pay, freeing them of past mistakes so that new money can be put to productive use. Banks resume lending, and the stock market bottoms, signaling that the recession will be over soon. Budding optimism reverses the vicious cycle of losses. A bull is born.
A more probable outcome is the one drawn from the narrow history of bear markets that grew out of financial crises. In it, the bear scenario continues to play out until the bull takes over, with more debt busts and government trial and error until things get set right again. That could mean two more years of bouncing around and then another six or so before the Dow is back above 14,000. Not long ago, such an outcome would have seemed unimaginably bleak. Given the other possibilities, it doesn't seem so bad now.
Why Wall Street Desperately Needs A New Bull Market
As this is written, the stock market has just staged a comeback of sorts. Yesterday (March 16th) marked an end to four consecutive days of positive returns, something not seen since November of last year. The Dow closed up just over 9% for the week, even after falling to its lowest level in 12 years on March 9th. Is the bear market over? Have we seen the bottom of the market? Can you again trust your buy-and-hold advisors who counsel you to “stay the course?” Maybe, but don’t count on it.
As the above article indicates, a new bull market may not be just around the corner, and David Henry isn’t the only one saying so. Peter Schiff, an analyst and fund manager also nicknamed “Dr. Doom” for his early warnings about the subprime crisis, says the worst is not yet over. A January 23rd Fortune magazine article highlights Schiff’s evaluation of the current situation:
More recently, Schiff has provided a counter-argument to the idea that the market’s recent rally marks the end of the current bear market. In a March 11 entry on his Internet blog (http://peterschiffblog.blogspot.com), he again states his opinion that the bear market is not yet over. Though he concedes that we could see a bear market rally (read: sucker rally) that lasts for a period of weeks or months, he notes that such rallies were common in the 1930s and do not necessarily point to an end of the current bear market.
I think one of the reasons the analysts that are calling the market bottom get so much attention is because Wall Street and the financial media so desperately need a new bull market to appear. Quite frankly, it’s the only kind of market environment where their buy-and-hold investments are likely to work, so it’s really sort of a matter of survival. If our experience is any indication, investors are leaving buy-and-hold investments in droves, no longer heeding the tired old “stay the course” message.
Yet, these purveyors of the failed buy-and-hold strategy continue to advise clients to stay invested. If you exit the market, they say, you’ll miss out on the big market moves that usually occur early in a new bull market cycle. Of course, what they don’t say is that if you get out, they’ll miss out on their fees and possibly commissions too, but they don’t like to dwell on that.
In reality, many financial firms simply have too much invested in software, marketing materials, broker training, etc., etc. to toss their buy-and-hold strategies in the garbage can where they belong. Almost every day, we get calls from investors who are tired of listening to advice that puts a financial firm’s best interest above their own. Good for them!
The stories we hear from new investors calling us now are all different, but really they are largely the same. They had a comfortable retirement nest egg going in the late 1990s. The multi-decade bull market, and their buy-and-hold strategies, had served them very, very well for two decades. But then came the tech bubble bursting in 2000 and the bear market of 2000-2002. Unfortunately, I don’t think that bear market really got the attention of investors, especially with the market rally in 2003.
Next, we experienced the subprime crisis, and next the freeze in the credit markets, and an unprecedented bear market in stocks in such a short time. Stocks have plunged well over 50%, and buy-and-hold strategies have collapsed commensurately over the last year. Now, investors who have believed in buy-and-hold for years are abandoning such strategies in droves.
Two gut-wrenching bear markets since 2000 have shown investors and brokers alike that the “stocks are best for the long haul” mantra may not be the best alternative. After all, what is the “long haul?” Unfortunately, buy-and-hold strategies may require a time period far beyond the realistic time horizons of many investors.
These bear markets have also illustrated that the asset values can vanish into thin air at the very time they are needed the most, even though “proven” diversification and asset allocation (buy-and-hold) techniques have been employed. The most recent bear market is a good case-in-point, where once non-correlated asset classes all plunged in value at the same time.
I have argued for years that the buy-and-hold strategies advanced by Wall Street and “Modern Portfolio Theory” were fatally flawed, and it would be nice to conclude that I told you so. But that misses the point. The only question now is how to go forward without incurring 50+% losses in the future. If my argument for avoiding huge buy-and-hold losses has not gotten your attention by now, I guess it never will.
But if it has, I offer the following advice as to how to get started. I have offered this line of reasoning for over two decades, and it has worked consistently for many investors.
Make Half A Decision
“You don’t want to abandon the investment strategy (buy-and-hold) that worked so well for you during the bull markets of the 1980s and 1990s,” or so you have been told by your broker or financial advisor. But now your portfolio is down over 50% and your retirement plans are in shambles. Now, finally, you are open to other ideas. Good. What follows is an easy way to get started comfortably.
Frankly, we realize that the type of investment strategies we recommend are very different from what most investors, and even many investment professionals, have been educated to believe. Since the onset of the bear market back in October of 2007, my staff has told me of many calls from investors who are interested in the actively managed programs we recommend, but who are reluctant to make the change.
In those cases, we suggest that investors consider making “half a decision.” In other words, place only half as much as you might otherwise commit to active management strategies, as long as applicable minimum investments are met. We have many investors who will test the waters with smaller accounts before making a full commitment to active management strategies.
I am so confident that active management strategies will prove their merit versus buy-and-hold strategies that I welcome you to make half a decision in regard to your investment portfolio. If you prefer, open a minimum account in one of the actively managed programs we offer in our AdvisorLink® Program. Once you see the difference between the performance of your actively managed investments and your buy-and-hold strategy, I believe you’ll begin to see the light. Of course, there are no guarantees in regard to the future performance of any investment.
This is a very good way to get started, in my opinion. Based on how the buy-and-hold mantra has served you over the last several years, maybe now is the time to try something different with at least part of your portfolio. Think about it.
For more information on the programs I recommend, and have most of my own money invested in, feel free to give one of my Investment Consultants a call at 800-348-3601 or, if you prefer, send us an e-mail at firstname.lastname@example.org. You can also obtain more information on our website at www.halbertwealth.com. Whatever you do, don’t let buy-and-hold’s empty promises continue to decimate your portfolio.
Hoping we can help you in these tough times,
Gary D. Halbert
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Forecasts & Trends E-Letter is published by ProFutures, Inc. Gary D. Halbert is the president and CEO of ProFutures, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, ProFutures, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.