This week I’d like to coddiwomple through making mistakes and staying data-dependent to gain a...
Secular bull, secular bear: What do I see for the years after 2013?
01/15/2013 8:30 am EST
But this year I think a focus on the course of markets in 2013 risks missing the forest for the trees.
Two longer-term questions are much more important to investors than whether the indexes finish 2013 flat with the end of 2012, or up or down 10%.
Is the cyclical bull market that began in 2009 due to end this year or next?
And how long can we expect the secular bear market that began in 2000 to run?
The differences of opinion about the duration of the secular bear market make the distance between optimists and pessimists on markets performance in 2013 look very, very small. And, of course, the duration of the current secular bear market is far more powerful in determining the returns that investors will experience over the next decade than getting the direction of 2013 right.
Both the optimists and pessimists seem optimistic about 2013. The estimates in Barron’s annual yearend survey of forecasters cluster in the range of 1550-1600 for the Standard & Poor’s 500. That’s a gain of 8.7% for the pessimists versus a gain of 12.2% for the optimists. The top of the range is 1660 and the bottom is 1434. The bottom would leave the S&P 500 pretty much where 2012 ended at 1426.
The real disagreement for 2013 seems to be about volatility with most of the worry concentrated in the first half of the year. Some of that is clearly a reflection of a belief that the battle over raising the debt ceiling, fixing the automatic sequester cuts, and agreeing to fund the government past the end of February with either an actual budget or another continuing resolution will whipsaw emotions and the indexes. (I’ve described this three-fold crisis in my post http://jubakpicks.com/2013/01/08/the-next-u-s-budget-crisis-is-serious-heres-why-and-how-to-navigate-it/ ) And then, of course, there’s the possibility that the euro debt crisis isn’t really over with a potential revival of fear over Spain and Italy on tap for 2013. The most pessimistic views that I’ve seen call for the current rally to yield to a major sell off in late spring with a return to end of 2012 levels by the end of 2013. Under that scenario, while the net gain/loss on the index wouldn’t add up to much, 2013 would present plenty of opportunity to buy high and sell low.
But this disagreement over gains/losses in 2013 is dwarfed by the chasm between bulls and bears over what happens after 2013.
The argument is over whether we’re still in a secular bear market that began in 2000 or whether a new secular bull market began in 2009. The kind of cyclical bull and bear markets that forecasters are talking about when they talk about what will happen in 2013 are relatively short in their duration. According to Ned Davis Research, the average length of the cyclical bull market from 1900 to March 2009 was 2.1 years. Five lasted longer than that—an average of 3.6 years. The average cyclical bear market lasts for something around a year.
On the other hand, secular bull markets can stretch on for a decade or even two. The last secular bull market ran from 1982 to 2000, for example. Secular bear markets can also last for a decade or more. The last secular bear market ran from 1966 through 1982.
The current bull market that began in March 2009 is now 3.8 years old. That’s considerably longer than the average cyclical bull market and longer than the average for the five longest cyclical bull markets.
I think you can see why the question of whether this is a cyclical bull on its last legs or a secular bull just getting started might be important.
The school that holds that we began a new secular bull market in March 2009 is looking for a correction from the current market highs but it expects that the secular bull market will resume relatively quickly. How quickly? I’ve seen forecasts that say just six months to others that look for a cyclical bear to last from sometime in mid-2013 to sometime in 2014.
The other school, the one that holds that we’re still in a secular bear market, also sees this cyclical bull market ending in 2013 but believes that this end won’t be short-lived but will instead usher in a resumption of the secular bear market that began in 2000.
The arguments between these two schools can quickly head into very technical discussions of technical patterns in the market and what they might mean. The secular bull market folks, for example, point out that none of the downside volatility that investors have experienced since the S&P 500 hit a bottom of 683 in March 2009 has taken the index below the March low. For example, in 2011, yes, the 14% drop from July 21 to September 28 was painful but at 1156 the bottom was well above the March 2009 bottom. Same with the drop of 14.6% from April 20, 2010 to June 30, 2010. That drop took the market back to 1031, still above the March 2009 low.
What the market has demonstrated since March 2009 is the pattern of higher lows and higher highs that defines a bull market.
I think that argument is true but saying we’re still in a bull market that began in March 2009 because of this higher highs/higher lows pattern doesn’t tell us whether this is a secular or cyclical bull.
To get a solid answer to that question, I think you need to look at the fundamentals behind the rally from the 2009 bottom and what we can tell about those fundamentals in the relatively near term.
To me the world’s central banks have been the driver in the bull market that took off after the global financial crisis. The Federal Reserve, the European Central Bank, the Bank of Japan, the Bank of China, and other national central banks have pumped money into the global economy to, first, head off the potential collapse of the world’s financial system, and, second, to stimulate the world’s economies. They’ve done this by driving interest rates to historic lows near zero in the United States and Japan, and to historic lows in the EuroZone.
And by pumping money into global economies through programs of bond buying that effectively created money. To take just two examples, the Federal Reserve’s balance sheet expanded to $2.92 trillion in the week ended on January 10. That’s roughly three times the size of the balance sheet before the financial crisis. The European Central Bank’s balance sheet hit a 2012 high in June at $4.15 trillion (at recent dollar/euro exchange rates.)
Even in normal times creating that much money would have increased the value of financial assets. Some of that newly created money would flow into the real economy in the form of investment in things like new factories. Some, however, would have flowed into purchases of stocks and bonds and real estate as well.
But these haven’t been normal times. With companies often reluctant to invest and banks often reluctant to lend to the real economy, a larger than usual portion of this created money has flowed into financial assets. And some of that was absolutely intentional as central banks tried to re-inflate collapsed real estate markets, recapitalize damaged banks, and prop up the government bonds of troubled countries in the EuroZone. Add in the effect of low interest rates on asset prices—when new bonds pay just 0.25%, older bonds with higher coupons and stocks with higher dividends rise in price—and the central banks have provided considerable fuel for a bull market in stocks and bonds. Of course, central banks were glad to see stock and bond markets moving up since the wealth effect created by rising markets led to an increase in consumer confidence and a pickup in spending.
But you should be asking Now what?
The Federal Reserve is committed to a program of asset purchases of $85 billion a month through the end of 2013 (probably.) But that’s not an increase.
The European Central Bank proudly noted at bank president Mario Draghi’s last press conference that it had begun to shrink its balance sheet. (Although a new flare up of the euro debt crisis would quickly reverse that shrinkage.)
The Bank of China seems to remain committed to stimulating China’s economy, but it has moved relatively carefully, holding off on interest rate cuts for longer than expected, for example. An increase in inflation in December to 2.5%, while still below the government’s 4% target, certainly won’t make the bank less cautious.
Of all the world’s major central banks only the Bank of Japan is increasing its program of monetary stimulus. The Bank of Japan is expected to increase its inflation target to 2% on January 22, which would commit the bank to a big increase in bond buying and to other measures that would weaken the yen.
I look at the argument about secular bull/secular bear through the prism of global central bank policy. The central banks have fueled the bull market that began in 2009 by creating trillions in cash, much of which flowed into financial assets. I don’t see the banks releasing another flood of cash on the global economy absent a new global crisis. (Which would not be good for asset prices, of course.)
Does that mean that global financial markets will tumble?
Not necessarily. Increasing corporate earnings could prop up stock prices at current levels or even move them higher in the months ahead. Wall Street optimists seem to be counting on this for the second half of 2013. But with the EuroZone economy in recession and U.S. growth looking weaker at least in the first half of the year, I find it hard to make a strong argument that U.S. stock prices should end the year markedly higher than they are now on earnings.
And I think that then leaves the decision on secular bull/secular bear up to two other factors.
First, can a recovery in economic growth in China and increased economic growth in the rest of Asia power global financial markets in those countries absent support from U.S. or European markets? This would require that emerging financial markets decouple from developed world markets. (Or that they advance strongly enough that they drag developed markets behind them.) That’s not completely out of the question since valuations in emerging markets are relatively low and growth prospects are relatively high. But it would require that problems in Europe, Japan, and the United States not rise to the level that in 2011 and 2012 prompted global investors to shun any markets with a whiff of risk. If investors wind up buying U.S., Japanese, and Germany bonds with negative real yields again because they’re willing to pay anything for safety, then emerging markets certainly won’t outperform. I think that the current outperformance of emerging markets makes them attractive enough to overweight in the first half of 2013 and into the second half. After that, time to re-evaluate.
Second, can the world’s central banks manage to begin shrinking their balance sheets—a necessity to keep the faith of the financial markets—without throwing the global economy (and global financial markets) into reverse?
If there’s one thing that makes me pessimistic about financial markets during the next half decade or more, and that makes me give high odds to an end to the cyclical bull market and a continuation of a secular bear market, this is it. Shrinking a $3 or $4 trillion balance sheet without slowing an economy is horrendously difficult. So difficult that I’m not sure it can be done. Looking out over the next decade I see a combination of rising interest rates and slowly shrinking balance sheets eating into growth rates at a time when national governments are facing rising costs from aging populations.
It’s hard to see that as a recipe for a secular bull market. Rather it seems to describe the combination of low returns and high volatility that Pimco’s Bill Gross has called the new normal and that I’ve called the paranormal market. I think there are strategies for wringing a profit out of a market like this and I’ve described some of them in a series of posts on the paranormal market. You can begin that series with this post http://jubakpicks.com/ . Links in that post will take you to earlier parts in the series.
What I don’t think will work for investors in this period are strategies that are build on a hope that we’ll be going back to the great secular bull market of 1982 to 2000 anytime soon.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. The fund did not own shares of any stock mentioned in this post as of the end of September. For a full list of the stocks in the fund as of the end of September see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
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