An unpleasant task but it is important to step back and remember where we are in the greater cycle of investing.

Here are the three questions:

  1. Are we in a Secular Bear Market?
  2. What does a Secular Bear Market look like?
  3. Why are we in a Secular Bear Market?

The third question will help us to see the signposts for the next Secular Bull Market. The signposts are both political and interest rate driven.

Are we in a Secular Bear Market?

The answer is Yes. Does that mean the market will go in a straight line down and there are no investment opportunities to be had? No…except, as we shall see, Japan. Just as certain asset classes surged and corrected during the Secular Bull Market of the 80’s and 90’s, certain asset classes will surge and correct during a Bear Market Phase as well.

What does a Secular Bear Market look like?

Dow Jones Log ChartS&P500 log chartNikkei 225 log chart
Here is the Dow and S&P500 which can be put together in a few minutes using Yahoo Finance and Excel. Charts and statistics can be manipulated to tell a particular story and these charts are no exception. We have used a logarithmic scale (so a 10% rise in the 1950’s looks like a 10% rise in the 1990’s) and have squeezed it to emphasize the long term time periods. On top of that, we have laid lines of our choosing to frame your thinking. Why bother describing this? Because it is important to think about the construction of any chart that might influence your investment process. Don’t be afraid to draw different lines and even conclusions.
Source: Yahoo Finance DJIA, SPX, Nikkei

The most interesting thing to note about the two US market charts is that a Secular Bear Market is not a smooth downward progression that the words imply. A Bear Market is generally defined as a 20% drop from the peak but that definition refers to a cyclical bear market. And, since many of those 20% drops happen quickly in otherwise Secular Bull Markets, one can see how the general perception of a Secular Bear Market is formed. However, the longer term beast that prowls the financial markets these days is a generally sideways affair. Generally, because one always has the example of Japan, which has gone to great efforts to make the last 20 years as dreary as possible.

Why are we in a Bear Market?

This is an important question because it will help us find the signposts for the next phase. Despite many sunny assurances that the Great Recession is behind us, the world does not feel like it is enjoying a strong recovery. A big part of the problem is the structure of the developed world’s economies. After a long period of globalization and attendant wealth creation, the demands for pensions, government programs, subsidies, worker protections and the like have finally taken a toll on the fiscal positions of many European and US states. The government’s share of GDP has grown dramatically, particularly in response to the Global Financial Crisis. Good growth is being crowded out by Government growth.

What should we look for? Dramatic action. The US and Europe did not break out of the malaise of the 70’s until dramatic actions were taken. Governments in the US and Europe will have to make some hard choices over the coming few years in order to set up for the next round of economic growth. What signs should one look for? Political reordering, sneaky pension cuts for public employees, a change in Social Security retirement age in the US and perhaps a government willing to stand up to public employee unions.

On the financial side of the equation, the big problem is that there is plenty of liquidity being created in the banking system but very little is being turned into money that businesses and individuals can use.

ShadowStats Money Supply Chart

Courtesy of ShadowStats.com

Why isn’t money moving from the Federal Reserve to Main Street? Simply because it makes no sense for US banks to even look at making a loan.

Relative Yield CurvesThis chart is presented in a fashion that one might not be familiar with because we are showing it from the bank’s perspective. To a bank with access to short term Fed Funds, the dramatically steep curve in US dollar rates means that the bank can make a bundle in the US by simply borrowing at next to nothing and lending it to the US Government for a few years. Compared to the complexities of a 30 fixed rate mortgage, this trade is the path of least resistance. Not only do you not need loan officers, you do not need an advanced degree to lay on the trade.
Data Source: Bloomberg

For now, it means that banks and other financial institutions around the world will continue to crawl over each other to get in on the trade. That means continued dollar strength (UUP) and weakness in the British Pound (FXB) and Euro (FXE) for the foreseeable future.

The signpost to look for is the flattening of the yield curve. When the long end comes down (because the FED appears determined to keep the short end anchored near zero) the loan officers will be out in force to recycle the profits that are being racked up today. Once that engine restarts, expect to see a huge surge in asset prices, economic activity and eventually, inflation.

What to do in the meantime?

As we pointed out in the beginning of the post, the next few years will be dominated by the Secular Bear Market. That means a general sideways drift with plenty of smaller bull and bear cycles along the way. To make money in rotational markets one must pay close attention to asset allocation and being ready to shift assets between classes. The old “Buy and Hold” formula which worked so well for almost two decades will only deliver very slim returns with lots of volatility. We continue to refine and test the Fund King System to meet the challenges of these markets.

Right now the System is telling us to stay in the following asset classes: Emerging Europe (TUR is back), High Yield, India, Tech, Reits, US Consumer, US Small Caps and Homebuilders. In our commodities only portfolio, only Gold (GLD) and Silver (SLV) look interesting.

For more information, go to our Portfolios Page. Gold members can see the most recent recommendations.

Disclosures: We eat our own cooking so you can safely assume that we own, have recently owned or are about to own the ETFs discussed here. In this particular post, we do not own GLD or SLV although we have owned both in the recent past.


Filed under: AsiaCurrencyDeveloped MarketsETFInterest RatesMarket CommentUS

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