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Boeckh Investment Letter

Investment and economic commentary by J.Anthony Boeckh and Robert Boeckh

Why the Secular Bears Are Wrong (Part 1)

Be Wary of a Consensus

January 17, 2011

There is a pretty widespread consensus that U.S. stocks are in either a secular bear market or a sideways trading range that will last for years.  Such a view is not surprising since a consensus is almost always formed by what has already happened in the recent past, an experience that has not been kind to equity portfolios.  In the last 11 years, the U.S. experienced two of the worst bear markets in history and the S&P 500  is still 16% below its all time high in early 2000 in nominal terms.  After adjusting for price inflation, it is down about 35%. 

Defining secular bear markets in stocks is not straightforward.  They are generally thought of as lasting a long time, sometimes ten years or more.  However, that is not always the case.  The magnitude of decline is also a key factor and a dramatic decline that takes prices to unsustainably low levels can shorten the secular bear market very substantially.  Also, looking at total returns changes the picture considerably because dividend yields are high after a steep market decline.  Nonetheless, we will focus just on the trend of stock prices which is more conservative, (i.e., shows weaker performance) and provides a sufficiently accurate picture. 

Some think of secular bear markets as lasting until the previous highs have been sustainably exceeded.  However, this approach is not very meaningful for those dealing with the future and making asset allocations accordingly.  Others would define secular bear markets as those in which valuations (e.g., P/E ratios) continue to fall.  That can be interesting information in the sense that falling P/E ratios create a headwind for stock prices; but what ultimately raises investor wealth and improves balance sheets, is rising stock prices.  As a result, we consider secular bear markets to be those where prices are trending down or, in the case of bull markets, trending up. 

Our particular interest in such trends comes from an increasing concern that the secular bear market consensus now is too widespread.  A consensus usually is wrong when it has prevailed for a long time.  There is a good chance that this one is also wrong and investors should start taking a fresh look at where the long-term trend of U.S. stock prices may be heading.  Clearly, there is no way to “prove” that we might actually be in a secular uptrend.  Conditions always look terrible in the early stages.  When the prevailing news is fraught with dangerous macro problems after big losses, it’s natural to be cautious when there is a lot of gloom and doom around.  It is then difficult for investors to overcome groupthink and set aside their biases and emotions. 

The essence of the creation of a new base from which to launch a secular bull market is twofold.  The first is a market overreaction to all the obvious bad news.  The second is a silent, below the surface, adjustment to the well publicised macro problems that is largely obscured by the cacophony of bearish noise.  Households and companies, for example, do improve balance sheets and become more competitive after a credit crisis.