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Ride This Bull, But Be Ready to Jump
02/23/2010 9:42 am EST
When the long-term market is going nowhere, the stocks you choose and when you buy them can make a huge difference in your portfolio. Here's what to do now.
So this is a cyclical bull market of potentially three to four years' duration inside a secular bear market of potentially ten to 20 years? That's what I argued in last Friday's column.
All right, Sherlock, navigate that one for me and my portfolio.
The strategy is actually pretty simple. But the execution . . .
Well, it shouldn't be too hard for anyone who combines the self-confidence and iron nerves under pressure of a Stonewall Jackson, the sensitivity to rhythm and emotion of a Martha Argerich, and the psychic powers of the three witches in "Macbeth." (While I'm wishing, may I have a flying horse and a dragon, too, please?)
For the rest of us, executing a strategy that can navigate a relatively short-term bull market and a relatively long-term bear might be a bit of a challenge.
A challenge; but not an impossibility. Let me explain the nature of such a strategy so the challenge becomes clearer.
A Stagnant Market Doesn't Sit Still
Last week, I argued that we were still in a secular bear market—one that began in March 2000—and that could still have as much as another ten years to run, even though we are currently in one of the great cyclical bull markets of all time. How else would you describe a rally that produced a 70% gain from the March 2009 low to the January 2010 high?
But I don't want to rehash that argument here. Instead, I'll take my best shot at telling you how to navigate this bullish bear (or is that bearish bull?).
This is new territory for almost all of us. If you started investing anytime after 1982, until 2000 you'd been an investor only during a bull market. And one of the great bull markets at that. One that produced a 1,391% gain. Despite such setbacks as the great crash of 1987, when the Standard & Poor's 500 Index fell 20% in one day.
You'd have lots of useful experience—and the scars to show it—if you'd been an investor from 1968 to 1978. That was the heyday of the last secular bear market. On November 29, 1968, the S&P 500 topped out at 108.37. It wouldn't see that level again until March 6, 1972.
And even then that bear wasn't done with investors. The S&P 500 didn't climb above its 1968 high for good until August 17, 1982.
That secular bear added up to 14 years of going nowhere. It puts the ten years of going nowhere that we've been through since March 2000 in perspective, no?
Not that there weren't some great rallies in that bear market along the way, though. There was a rally from October 3, 1974, to July 10, 1975, that took the S&P 500 up 52% in about nine months. And biggest of all was the rally from May 26, 1970, to January 11, 1973—roughly two years and seven months—that produced a 74% gain for the S&P 500.
Turns out that the kind of rally that we saw from March 2009 to January 2010 isn't as unusual as you'd think.
Even in retrospect—maybe especially in retrospect—it's easy to see that how you did during the secular bear of 1968 through 1982 depended on what you did.
If you stood pat and didn't make any buys or sells during the whole 14-year bear, you would have finished the bear at no worse than even, plus the 2%-to-3% a year in dividends you would have collected on the S&P 500.
If you had held on and then sold at the bottom in 1973, you would have seen a loss of 42%.
Ouch. But you could have done even worse.|pagebreak|
You could have ridden the bear down from 108.37 on November 29, 1968, to 89.48 on July 29, 1969, and then sold. Then, if you'd stayed out of the market until a rally in 1970 persuaded you to buy back in at 90 and then sold again in disgust at the bottom of 62.28 on October 3, 1974, and then stayed on the sidelines until the market had rallied to 90 and then bought in again, only to ride it down to 82.09 on September 16, 1975, you would have been looking at a 53% loss by 1975. And you would still have had five to seven more years of failed rallies to buy into at the wrong time.
You think there's any chance that an investor who had been burned like that would have been too traumatized to jump into the great secular bull market that began in 1982 until, say, 1992?
A Secular Bear Survival Guide
OK, so what are the lessons from that decade and a half of bear market pain? And can we build a simple strategy from them?
I think so, even without the 20/20 hindsight that would have allowed an investor to buy at every temporary bottom and sell at every temporary top.
Let's try on these three rules for size as a foundation for our strategy:
- First, long cyclical bull rallies in secular bears produce gains so large that they are too important to miss. Sitting out for all of them leaves a lot of money on the table. And some of the biggest rallies last long enough for most investors to catch part of the profit. For example, while I was late to the party with Jubak's Picks in 2009 and never did get fully invested, I still managed to catch enough of the rally to produce a 20% return for 2009.
- Second, almost no one is going to catch all the cyclical bull rallies in a secular bear, especially if the bear is really deep. And most investors shouldn't try, nor should they kick themselves if they miss one or two. Remember that in a bear, staying on the sidelines beats buying high and selling low repeatedly in an effort to catch the next rally. If the bear is really deep, rallies off the bottom can be explosive and end quickly. The 52% rally from October 1974 to July 1975 was over before most investors recognized its existence.
- Third, the most reliable guide to when a long secular bear is over is the same guide that can tell us when we're in one: Fundamentals. I don't mean to denigrate technical analysis, not in the slightest. But reading the difference between a recovery rally inside a bear market and the rally that really ends a bear market using purely technical tools is so difficult that you should also look at the fundamentals of the economy and the stock market. Take help anywhere you find it.
Looking at the steady upward climb of interest rates during the 1968-1982 secular bear—5.64% on the ten-year Treasury in 1968, 7.99% in 1975, 9.43% in 1979, and 13.92% in 1981—should have made any investor doubt the staying power of any bull rally during the period.
The potential for interest rates to follow a similar course over the next decade that they did in 1968-1982 is one reason that I put the odds of a secular bear lasting five to seven more years so high.
What kind of strategy do I propose building on that foundation? One that pays attention to both short-term bull rallies and the long-term bear by realizing that whenever either trend, long term or short term, runs to an extreme, it opens up opportunities to buy into the other trend at a good price. And then to hold until the attention of Wall Street and the great majority of investors switches to the other trend and sends prices there toward an extreme.
Essentially, the strategy oscillates between going short and going long—only in this case we're not talking about short-selling and its opposite—but about switching our thinking from short term to long term and back again as one perspective or the other gets over- or undervalued.
So, for example, in the latter stages of the current cyclical bull market, gold and other hedges against inflation got relatively cheaper as stocks continued to soar.
Inflation? Who was worried about inflation? If it is a problem, it's a problem so far down the road that it's certainly not worth investing money in hedging against the trend or to make money from the trend.
But I'd argue that it's when everybody is focused on making money in the short-term cyclical bull that you ought to be thinking about putting some money into positions that will do better—or maybe just relatively better—in the long-term bear.|pagebreak|
I've posted repeatedly in the past few months (most recently in this February 18 post) laying out my reasons for believing that this cyclical bull could well continue through the first half of 2010. I hope it does.
But if the correction is indeed over (see this recent post) and the rally resumes, then I think the time to be adding new positions to take advantage of the short-term bull is just about over. Let your money ride, by all means. But start to watch valuations, and take some profits. And start to put some money into the long-term bear view.
In the coming weeks, if the rally heats up again, I'd be looking at gold and commodities. They're both likely to be increasingly overlooked, especially if the Federal Reserve's move to raise the discount rate—the interest rate the Fed charges banks for borrowing overnight—adds even more strength to the US dollar.
The same will be true for defensive stock market plays. Stocks backed by recession-resistant revenue streams, such as Procter & Gamble (NYSE: PG), or stocks with solid dividends, like DuPont (NYSE: DD), move to the top of investors' buy lists when the market is falling, and then they fall out of favor when a rally resumes. It's when they're out of favor that you want to add to positions in these kinds of stocks to prepare for the days when the bear is back in control.
Same with dividend stocks in general. When stock prices are climbing, dividend stocks get overlooked and become relatively cheap. But you'll want to own them when the rally ends. The time to buy them is before every guru in the blogosphere starts recommending them.
I think there's a similar short-term/long-term play on emerging market stocks. If you hope to avoid a lost decade or more, you'll have to add stocks from the world's fastest-growing economies to your portfolio.
Emerging market stocks are likely to go up—but even faster—when US markets are rallying. A rally in the developed world's stock markets usually convinces investors that it's safe to take a flier on the riskier (in their minds, at least) markets of the developing world.
When the bear shows itself, developing markets are likely to fall even faster than their developed-world counterparts as investors seek what they see as the relative safety of the US and other developed markets. That's the time to buy emerging market stocks.
The evidence of the last decade says that investors do indeed get more volatility when they buy developing market stocks, but the excess returns—the gains above what developed market stocks achieve—make the volatility more than worth it.
Over the next couple of weeks, I'm going to tweak the holdings in Jubak's Picks just a bit to see whether I can get something closer to the best mix for the end stages of a rally that I expect to peter out somewhere near the middle of the year.
But after those tweaks, I'll start looking for bargains that will let me build a portfolio prepared for the return of the bear.
At the time of publication, Jim Jubak did not own or control shares of any company mentioned in this column.
Jim Jubak has been writing "Jubak's Journal" and tracking the performance of his market-beating Jubak's Picks portfolio since 1997 on MSN Money. He is the author of a new book, The Jubak Picks, and he writes the Jubak Picks blog. He is also the senior markets editor at MoneyShow.com
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