The Secular Bear Market in 4 Stages

Friday, August 28th, 2009

The debate rages on as to whether global stocks markets have turned the corner and are in the early stages of a new secular bull market, or whether we are experiencing a secondary bear market rally (or cyclical bull phase) within a primary bear market.

Although I am not a big proponent of averaging data across multi-year cycles, an analysis of the various stages of a typical secular bear market by Teun Draaisma and the strategy team of Morgan Stanley Europe nevertheless provides food for thought. The chart below shows what a typical secular bear market looks like based on the average of the past 19 major bear markets around the globe.

Considering the aggregate data, the team summarized their findings as follows:

“Each involved a peak-to-trough decline of at least 40% lasting at least a year. The median of these bear markets showed a 57% decline over 30 months.

“The usual rebound rally is 71% over 17 months … Structural bear markets are always followed by a strong rebound, typically from the moment authorities take decisive action.

“A turn in the rate cycle is often the trigger for the next correction. Often the peak in the rebound rally has been around, or prior to, a change in the interest rate cycle.”

“Broad multi-year trading ranges followed the initial rebound in 10 of 19 bear markets. In most cases, structural problems in the real economy acted as a headwind to a new bull market, such as financial bubbles, high debt levels, fiscal deficits, current account deficits, deflation and high inflation.”

Looking at the present situation with the MSCI World Index up by 57.7% and the S&P 500 Index up by 52.4% since the lows of March 9, the Morgan Stanley team concludes: “If the aftermath of these 19 secular bear markets is anything to go by, the current rally could go on a bit longer; is likely to stall a few months before the first Fed rate hike, which we expect in Q3 of 2010 … and is likely to be followed by some sort of trading range for years to come because of the structural problems of financial sector and household deleveraging as well as the poor state of government finances.”

For those interested in the data of the various secular bear markets and subsequent movements, the table below makes for interesting reading.

Click here or on the table below for a larger image.

Source: Teun Draaisma, Ronan Carr, Graham Secker, Edmund Ng and Matthew Garman, Morgan Stanley European Strategy, August 10, 2009 (hat tips: The Big Picture and proshare),  August 27, 2009.

Tags: Account Deficits, Aftermath, Amalgam, Amp, Barry Ritholtz The Big Picture, Bear Markets, Bears, Bull Phase, Cfa, Chart Below Shows, Composite Pattern, Current Market, Debate Rages, Debt Levels, Edmund Ng, Fed Rate Hike, Financial Bubbles, First Fed, Fiscal Deficits, Garman, Global Stocks, Headwind, Interest Rate Cycle, Market Rally, Morgan Stanley, Morgan Stanley Europe, Msci World Index, Rally, Rebound, Ronan, Secker, Secular Bear Market, Secular Bull Market, Snapback, Spx, Strategy Team
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More on Bob Farrell’s Rule #8

Monday, August 10th, 2009

I posted “Bob Farrell’s Rules for Investing” a few days ago, and these words of wisdom turned out to be popular reading material.

Given the debate as to as to whether the US stock markets are experiencing a primary (secular) bull market or a rally within a primary bear market, i.e. a so-called cyclical bull market, Farrell’s rule #8 has caused a fair amount of food for thought:

“Bear markets have three stages - (1) sharp down, (2) reflexive rebound and (3) a drawn-out fundamental downtrend.”

In an attempt to put these stages in perspective, David Rosenberg, chief economist and strategist of Gluskin Sheff & Associates, provided a graphic illustration of Farrell’s three stages, as shown below.

Click on the image for a larger graph.

Source: Gluskin Sheff & Associates - Lunch with Dave, August 7, 2009.

Whether stock markets will enter a drawn-out downtrend remains to be seen, but given the magnitude of the rebound a pullback certainly looks likely. Caution seems to be in order.

Tags: August 7, Bear Market, Bear Markets, Bob Farrell, Caution, Chief Economist, David Rosenberg, Food For Thought, Gluskin Sheff, Graph, Graphic Illustration, Magnitude, Pullback, Reading Material, Rebound, Reflexive, Secular Bull Market, Strategist, Us Stock Markets, Words Of Wisdom
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Stock markets – secondary or primary bull?

Friday, July 31st, 2009

Ever since Richard Russell (Dow Theory Letters) called a “Dow Theory bull signal” last Thursday, the debate has been rekindled as to whether the US stock markets are experiencing a primary (secular) bull market or a rally within a primary bear market, i.e. a secondary or so-called cyclical bull phase.

As mentioned previously, Russell views the March 9 low as a secondary low, saying: “We are now in a cyclical bull market as opposed to a secular or primary bull market. In effect, we’re in an extended bear market rally. The true bear market bottom lies somewhere ahead.”

Irrespective of terminology, 64% of the readers of the Investment Postcards blog see the current phase as one characterized by “irrational exuberance”, as cleaned from a quick poll a few days ago.

As always, there are various signals pointing in different directions. The 200-day moving average of the S&P 500 Index just three days ago turned up for the first time since January 2008, after having been breached upwards by the Index in early June. The 200-day line is generally seen as a key indicator distinguishing between a primary bull and market.

Also, when considering monthly data, three momentum-type oscillators (RSI, MACD and ROC) are reversing course for the first time since the sell signals of 2007 and now either indicate buy signals (or are getting close to a signal in the case of MACD).

Source: StockCharts.com

Amid the uncertainty, the highly rated Ned Davis (Ned Davis Research) has just completed a research project in which he identified seven dimensions one could use to compare the March 9 low with secular lows of the past. His findings, as reported by Mark Hulbert on MarketWatch (hat tip: The Big Picture), were as follows.

(1) “Monetarily, money should be cheap and amply available”: Neutral. You might think that this factor should be rated as “bullish”, given how accommodative the Federal Reserve is currently. But Davis notes that banks are also significantly tightening their lending standards. Given the heavy debt load of both consumers and corporations suffer (see next criterion), banks are finding it “increasingly hard to find ‘credit-worthy’ borrowers”.

(2) “Economically, the debt structure should be deflated”. Bearish. This is the most negative of any of Davis’ seven dimensions, since the debt structure is by no means deflated. On the contrary, Davis calculates that the total credit-market debt load right now is nearly four times the size of gross domestic product, and that it takes more than $6 of new debt for our country to produce just $1 of GDP growth. That’s almost double the amount of debt required in the 1990s.

(3) “There should be a large pent-up demand for goods and services”. Bearish. Davis acknowledges that there has been improvement in this dimension from where things stood at the beginning of the bear market. But he is particularly worried by the ratio of total Personal Consumption Expenditure to Non-Residential Fixed Investment, which currently stands at a record high. At the secular bear market low in 1982, in contrast, this ratio was at a record low.

(4) “Fundamentally, stocks should be clearly cheap based upon time-tested, absolute valuation measures”. Neutral. Though the stock market “got undervalued at the March lows”, it never became “dirt cheap”.

(5) “Psychologically, investors should be deeply pessimistic, both in terms of the stock market and the economy.” Bullish. Davis says that past secular market lows were accompanied by extreme pessimism, and his indicators show a similar extreme existed earlier this year.

(6) “Technically, major investor groups should have below-average stock holdings and large cash reserves”. Neutral. While foreign investors have record-low stock holdings, according to Davis, household holdings - while low - are not nearly as low as they were at prior secular bear market lows. And institutional investors’ stock holdings “are only down to an average weighting historically”.

(7) “A fully oversold longer-term market condition in terms of normal trend growth and in terms of time”. Neutral. Davis believes that, though many of the excesses of the real-estate bubble have been worked off, some still exist. That’s particularly a problem, he says, given that the stock market bubble of the late 1990s never completely deflated either. “As we saw in Japan after 1990, a double bubble in stocks and real estate leaves it difficult to put ‘humpty dumpty’ together again.”

The research shows that only one of the seven criteria indicates that a secular bull is in place, whereas three are neutral and three are bearish. Although Davis believes the nascent rally has more upside potential, he concludes, like Richard Russell, that we are dealing with an extended rally (cyclical bull phase) within a secular bear market.

Looking at the next few weeks, I take a somewhat different perspective and am of the opinion that stock markets have run away from fundamental reality and that a pullback/consolidation looks likely. Taking a slightly longer-term view, I think we are in a (possibly lengthy) bottoming-out phase as far as slow-growth (OECD) countries are concerned, but already in new (potentially volatile) uptrends regarding high-growth emerging and commodities-related markets. Above all, I believe one should be careful of over-analyzing broad indices and at this stage of the cycle focus more strongly on selecting individual stocks with strong balance sheets and dividend-paying potential.

Related posts:

Dow Theory calls a bull market
How to interpret the Dow Theory bull signal, according to Richard Russell

Tags: Bear Market, Big Picture, Bull Phase, Commodities, Dow Theory Letters, Federal Reserve, Hat Tip, Irrational Exuberance, Last Thursday, Lows, Macd, Mark Hulbert, Market Bottom, Market Rally, Moving Average, Ned Davis Research, Quick Poll, Richard Russell Dow Theory, Roc, Secular Bull Market, Us Stock Markets
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Is Rosie Right on Bonds?

Wednesday, July 15th, 2009

The paragraphs below are excerpts from a recent report by David Rosenberg, chief economist and strategist of Gluskin Sheff & Associates.

“The consensus says that the era of the secular decline in government bond yields has come to an end because of the very low yields and the massive reflation efforts from governments everywhere. The consensus is that inflation is going to have to show up somewhere at some point. That may well be true, but despite huge policy initiatives, long-term bond yields did not hit their bottom in the US until late 1941 at below 2% and this was a good 12 years after the initial shock.

“Nobody built more bridges or paved more river beds than the LDP did in the 1990s in Japan, and despite a doubling in the government debt-to-GDP ratio and multiple credit downgrades, the yield on the 10-year JGB did not hit their lows at less than 1% until 2003 - again, this was 13 years after the initial shock. To be sure, there were selloffs and spasms along the way, but it took years for fiscal and monetary policy to finally break the downtrend in bond yields.

“To be sure, this has been a brutal year for US Treasuries, with the yield on the 10-year note nearly doubling this year at the June 10 peak of 3.98% (though the Treasury market has generated a +2% return so far in July - the first positive showing since March). From our lens, it cannot be said that the secular bull market in bonds is over until the 10-year breaks above 5.26% because then and only then will we be able to say that for the first time in this 28-year secular bull phase, the prior interim high was ‘taken out’. Look at the time series below and you will see that ever since bond yields peaked during the inflation bubble of 1981 they kept on hitting lower and lower ‘highs’ during the eight cyclical selloffs, and they continuously made lower ‘lows’ during the intermittent eight cyclical rallies. That is how a secular bull market is ultimately defined:

October 26, 1981 (High): 15.60%
October 13, 1982 (Low): 10.39%
June 25, 1982 (H): 14.76%
May 4, 1983 (L): 10.12%
August 8, 1983(H): 12.20%
April 6, 1986 (L): 6.98%
March 20. 1989 (H): 9.53%
October 15, 1993 (L): 5.19%
November 7, 1994 (H): 8.05%
October 5, 1998 (L): 4.16%
January 20, 2000 (H): 6.79%
June 13, 2003 (L): 3.13%
June 12, 2007 (H): 5.26%
December 8, 2008 (L) 2.08%
June 10, 2009 (H): 3.98%
Today: 3.26%.

“Keep in mind that over half the time, bond yields hit their fundamental lows in the June-December period; and we also know that Treasuries have rallied in 15 of the last 20 third quarters. So the seasonals, if nothing else, are quite positive for the fixed-income market during this time of year.”

Will Rosie be on the money? I am not so sure. The graph below shows the historical relationship between the US GDP-weighted Purchasing Managers Index (PMI) and the yield on 10-year Treasuries. Should the PMI show further improvement and break above 50 (indicating expansion), long bond yields may not have much downside potential. In any event, I am not sure who wants to sink money into a 10-year T-Note with a 4% coupon that is losing 6-8% a year as a result of dollar depreciation.

Source: Plexus Asset Management (based on data from I-Net Bridge).

Tags: Bond Yields, Bull Phase, Chief Economist, David Rosenberg, Downgrades, Fiscal And Monetary Policy, Gdp Ratio, Gluskin Sheff, Government Bond, Government Debt, Initial Shock, Jgb, Look At The Time, Policy Initiatives, River Beds, Secular Bull Market, Secular Decline, Selloffs, Term Bond, Treasury Market
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Commodities: A Favourite Theme

Thursday, June 11th, 2009

The Reuters/Jeffries CRB Index - an index that was first constructed in 1957 and comprises 19 major commodities - has been rising non-stop for the past four weeks and for nine weeks out of the past 14. This surge represents a gain of 30.2% from its low on March 2. But one needs to put this in perspective: the Index fell by 57.7% from its high in early July 2008, and therefore still needs to rise by a further 81.5% to match the previous peak.

I posted an article a week ago entitled “Secular bull in commodities remains intact” and concluded as follows:

“… commodities still seem to be in a supercycle that was only temporarily interrupted by the global economic malaise. As inflation money finds its way into commodities, it is still not too late to purchase these, but only on price corrections that are bound to occur from time to time.”

David Rosenberg, chief economist and strategist of Gluskin Sheff & Associates, concurred, saying: “… what we experienced last year was a severe cyclical correction in what is still a secular bull market - you can connect the dots on the chart and see that the CRB looks a lot like what the S&P 500 looked like in the months following the sharp 1987 collapse. It seemed like the end of the world in October of that year, and yet in retrospect it was just the fifth year in what proved to be an 18-year secular bull phase.”

Bringing technical analysis to the equation, Adam Hewison of INO.com has prepared another of his popular analyses, specifically on the CRB Index. Click here or on the image below to access the short presentation.

Tags: Bull Phase, Cape Town, Chief Economist, Collapse, Commodities, Crb Index, David Rosenberg, Dots, Economic Malaise, Gluskin Sheff, inflation, Jeffries, Nine Weeks, Retrospect, Reuters, Secular Bull Market, Strategist, Supercycle, Target, Time David
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Asian markets won’t retest lows, says Chris Wood

Thursday, June 4th, 2009

Chris Wood, street smart Global Equity Strategist of CLSA, yesterday said in an interview on CNBC-TC18 that the US markets remained in a bear market rally while Asia and India were in a secular bull market.

He said the Indian and Asian rally was started by local money, which according to him was a big long-term positive. He added that Asia and emerging markets (EMs) would be the biggest beneficiary of the Fed’s monetary easing. He also said liquidity could lead to massive asset bubbles in Asia and EMs.

Click the image below to view the interview. The video clip is followed by a verbatim transcript.

Q: What have you made of the markets’ move in the past few weeks?

A: I was expecting what I call a counter-trend rally, driven by a counter-trend rally in the S&P this year. The key point is that the S&P in the fourth quarter last calendar year went further below its 200 DMA, and at any point since 1932, in the midst of the Great Depression. So, it was almost inevitable that we were going to have a counter trend rally at some point in 2009. Actually, I thought it would start with the arrival of the new administration in January-February, but it didn’t start so much.

My guess as to how far this rally can go is 1000-1050 on the S&P, but I am viewing this as a counter-trend rally in a secular bear market for the US. I have a different view for Asia and India. I believe Asia and India remain in a secular bull market. So I have a fundamentally different view for the Western world and Asia.

Q: How would you describe what happened in 2008 then in India and other Asian markets like China? Deep cyclical correction? Over 10-15 months in an overall secular bull market?

A: I would describe that as a deep cyclical correction in Asia and EM driven by massive collective damage from what was going on in the Western financial system. That is why with my Absolute Return Portfolio I have been recommending to investors from the middle of 2007 only to own my recommended portfolio, by hedging the Western financial risk by being short on Western financial stocks. But in my view, the sell-off in Asian stocks last year was exacerbated by dramatic liquidation by foreign money, particularly by hedge funds and so-called funds of funds.

What is positive in the rally that began in Asia in October-November last year is that we’ve seen growing local investor participation in Asian market, so the people who bought earlier in this rally since late last year weren’t foreign fund managers but local investors throughout the region. That growing local investor participation is a long-term positive.

Q: So are you saying that the secular bull market has commenced again in India and other Asian markets?

A: Yes, I think it has recommenced. Two technical pieces of evidence support that view. First, Asian markets and EMs have been leading this rally ever since they bottomed last October-November. Second, when the S&P made a new low in March, the Asian markets and EMs did not make a new low. That is technical evidence to me that Asian markets and EMs have become the asset class of choice in global equities.

In the very short term, because Asian markets and EMs have outperformed dramatically, there is some scope for the S&P to outperform. However, in the long run, in my view, the asset class of choice in which to remain fundamentally overweight is Asia and EMs.

In my view, the biggest beneficiary of the dramatic monetary easing, quantitative easing undertaken by the Western central banks led by the Fed, won’t be American/British consumers or American/British stock markets. The biggest beneficiaries will be Asia and EMs. In fact, the dramatic monetary easing could lead to massive asset bubbles in due course in Asia and EMs because the excess liquidity will flow to the best growth story and the best growth stories in the world are Asia and EMs. They have the best demographic dynamics and have the healthiest economies because, unlike the Western world, they do not have the structural leverage problems.

Q: Often, the measure of the restart of a bull market after a bear market is when the previous highs get taken out. How long is it before you think India and other Asian markets can take out their old bull market highs?

A: I don’t assume that happens quickly, because I am bearish on the Western world. If I wasn’t bearish on the Western world, then I would say very quickly, but I am. So in my view we are in a process here, we have commenced a process of incremental decoupling from Western markets. At the beginning of 2008 many investors in China and Indian equities believed in decoupling but by the end of 2008, after a dramatic collapse in Asian stock markets after the Lehman bankruptcy, investors stopped believing in decoupling and started believing in the absolute opposite.

The absolute opposite was an export-correlated train wreck with the US consumer. People became extremely negative on the most important EM story, which was not India but China. This year the Indian and Chinese economies have shown growth momentum; those very bearish concerns were misplaced. So we now have some empirical evidence that Chinese and Indian economies are able to decouple to a certain extent from the American economy, from the American consumer.

The American economy is not growing, so that is building confidence in asset classes. We have begun the process of incremental decoupling. But I think unfortunately when the S&P turns down again, when people realise that it is an L-shaped situation in the US, not an U-shaped or V-shaped recovery, you will get renewed correction. But my view is that next time the Western stock markets go down the Asian markets will prove much more resilient. But this process is incremental; it is not going to happen on a 12-month view.

Q: How bearish are you on the US markets?

A: I would expect a retest of the 660 level in due course in the US if the equities correct and it coincides with the new dollar rally because the dollar rally is on deleveraging. But if the dollar keeps declining, the lows on the S&P need not be so large because some of the downside will be taken on the dollar.

Q: Even if the S&P were to go for a retest you think none of the EMs, including India, will go for a test of their 2008 lows?

A: I don’t believe in a world where the S&P revisits the lows of March. I don’t think the Asian equity markets, India, will revisit the lows because the Indian economy has demonstrated its domestic demand-driven resilience this year. We are now getting people talking of 5.5-6% growth - a few months back the RBI had come out with statements that growth was going to be much slower than expected and it said that growth was going to be 6%.

Reality is that at the beginning of this year investors thought 6% was not attainable, but the data that have been coming out have been a positive surprise. The Indian economy is keeping its growth - not by artificial stimulus measures by the government - so basically the data have been a positive surprise this year and the government has been another positive surprise, which has been a clear mandate that should allow a more coherent policy that should allow for a renewed vigour in the infrastructure cycle now.

Q: How positive is the election?

A: I don’t want to over-dramatize it because of the Indian government’s history of disappointing on reform expectations. But I what I do think is positive is that most foreign investors were on the sidelines before the election as they knew the situation is inherently unpredictable. So because of the clarity and because you don’t have a weak coalition government, I think that was a major catalyst for foreigners to reinvest in India, and logically the sector that should benefit is the infrastructure sector. The other point is that it has removed the risk that the fiscal deficit in India could get out of control.

Q: What are you overweight on in India and China?

A: I am overweight both on India and China but in the last quarter more India, because I was more overweight China in the first quarter. But in my long only portfolio, I am 33% in India and my biggest weight is in Indian banking though I did add an infrastructure name after the election.

Q: Public sector units or private sector?

A: Both, but if I were making a new allocation it would be to a private sector bank.

Q: This trait to tanking up to defensives, you think that trend is over?

A: Tactically, Asian markets have had a big rally and people were fortunate to be in the high-beta names and they should be thinking of moving to less-high-beta names now, 70-80 on the oil price, you should reduce the beta names. But I would reduce in the commodity-driven stocks, not banks.

Q: Do you find any discomfort with regard to valuations in India?

A: PEs look scary in India, especially infra, but India is a genuine domestic demand-driven growth story. So it deserves a high PE premium. On a price to book basis India looks undemanding. The whole risk in Asian valuations is in the potential negative correlation to the Western world.

Source: CNBC-TC18, June 3, 2009 (Hat tip: Viktor Capitalist).

Tags: 15 Months, Absolute Return, Asian Markets, Beneficiary, Bubbles, Cnbc, Dma, Emerging Markets, Ems, Global Equity, Great Depression, India, Key Point, liquidity, Lows, Market Rally, New Administration, Retest, Secular Bear Market, Secular Bull Market, Strategist
Posted in Emerging Markets, India, Markets | No Comments »

Treasury Bills - Is This The Low?

Tuesday, January 13th, 2009

This post is a guest contribution by Bennet Sedacca*, President of Atlantic Advisors Asset Management

In the chart below, please note the very simple channel in long bond futures going back to the beginning of the bull market. Prices seem to top every 5 years and, right on schedule, they’ve topped again.

Click here or on the chart below for a larger image.

The usual correction is in the 18-25% range if it revisits the lower end of the channel. From the top, at roughly 142, a 25% move would be to 106 or so, which is still a whopping 4.4%. I think is far too low considering a) what actually now sits in the Treasury and b) the sheer amount of global supply that is forthcoming. Even in a slow economy, I think foreigners will need to be sellers. I am finishing up my Mortgage Backed Securities program today and heading to more cash.

One more thing. The secular bull market in stocks, in my opinion, ran from 1974 to 2000. Twenty-six years. The bull market in bonds looks like it ran from 1982-2008, also twenty-six years and exactly the length of time I have been at this. With the “blow-off” move we just had, my guess is that the top is in, perhaps for a very long time … like a decade.

Using a Fibonacci analysis leads us to targets that are … well, nauseating and could be a 50% retracement of the whole move. So buyers of long bonds beware. And if you want to refinance, and can actually find a good program, I wouldn’t hesitate. That goes for individuals and corporations alike. Why the Treasury is BUYING bonds at these levels instead of selling long Treasuries is beyond me.

Click here or on the chart below for a larger image.

* President of Atlantic Advisors Asset Management, Bennet Sedacca brings with him more than 26 years of securities industry experience. From 1981 to 1997 he worked for several major investment banks, specializing in high-grade fixed-income securities marketing, trading and portfolio management. In 1997 he formed Sedacca Capital Management focusing on portfolio management for high-net worth individuals and small to mid-sized institutions.

Tags: Asset Management, Bond Futures, Buying Bonds, Fibonacci Analysis, Fixed Income, Foreigners, Global Supply, Income Securities, Industry Experience, Investment Banks, Length Of Time, Mortgage Backed Securities, Portfolio Management, Retracement, Secular Bull Market, Securities Industry, Slow Economy, Treasuries, Treasury Bills, Treasury Bonds
Posted in Bonds, Economy, Markets | No Comments »