A Super Bear Is Upon Us
(November 21, 2008)
Based on the historical data that I have been monitoring and my personal experience that I have had with the previous secular bear market, which ended in 1982, I believe that a new secular, or a “super,” bear market was born on Oct. 9, 2007.
To confirm my belief that we are indeed in a new secular bear, the Dow Jones Industrial Average would have to close below its Oct. 9, 2002 low of 7,286.27. I believe that the confirmation low will be breached during the fourth quarter of 2008 or the first quarter of 2009.
A super or secular bear is much different than your cyclical or garden variety bear because its birth is a signal that equities and mutual funds will have mediocre performance for between eight and 20 years.
This is because the minimum number of years has been eight for all secular bull and bear markets since 1802. Given the viciousness of this secular bear, I believe that the bottom for the major indices such as the S&P 500 and the Dow Jones 30 Industrials will be far below the lows that were reached in Oct. of 2008.
I am also predicting that at the S&P 500 will eventually get to at least 547.75, which is the equivalent of 65% off of its all-time peak, and that the Dow Jones Industrials will go to at least 5665, which is the equivalent of 60% off of its all-time peak. Since the stock market has now entered the rare secular bear phase, I am predicting that the all time record highs that were reached by the major indices including the Dow Jones Industrials and the S&P 500 on Oct. 9, 2007 will not be exceeded over the next 10 to 20 years.
Continue reading this article if you want to understand my reasoning as to how I came to these conclusions.
While I am both realistic and pessimistic about the “overall” market for the next 10 to 20 years, I believe that “educated” investors who focus on buying and holding stocks instead of mutual funds, ETFs, and indices will be in the position to make fortunes. They will be able to do this in this secular bear without having to trade, employ leverage, or even short the market.
I have fond memories of the previous 16-year secular bear in which I was a participant. Also, I remember the IPO market as being spectacular during the secular bear. For example, Federal Express shares appreciated by over 100% by 1982, after going public in 1979. Federal Express shares have since multiplied thirty fold based on their most recent closing price. As an analyst, writer, and investor, my preference is to participate in a secular bear instead of a secular bull. I am giddy and excited about this secular bear because I believe that it will provide unprecedented investment opportunities.
Upon joining Merrill Lynch in 1977 as its youngest broker ever, I was thrown into the den of the last secular bear, which began in 1966 and ended in 1982. In 1978, I began recommending GEICO shares to my clients at under $8.00 per share. In the year the secular bear died, in 1982, GEICO shares had appreciated by over 500% to over $40 per share. It was eventually acquired by Warren Buffet’s Berkshire Hathaway for $70.00 per share.
Also, in 1978, I watched in amazement as many of the gambling stocks appreciated by five times in value and the shares of casino company Resorts International appreciated by over thirty times in value during that year.
While employed at brokerage firm Donaldson Lufkin & Jenrette (DLJ) in 1984, I was privy to a research report, which was titled “More than a Year.” The basis for the report was that DLJ’s research department had found 250 stocks that had gone up a “median” 19 times between 1974 and 1983. I was able to gain access to the data and I was flabbergasted as I found that the best performer on the list, Key Pharmaceuticals, went up by over 1,600 times between 1974 and 1983.
There were many stocks on the list of the 250, which increased by over 100 times in value over the ten-year period. I am truly and excited about the birth of this secular bear because it will give long-term investors, such as myself, the opportunity to make returns of 10 to 20 times our money over the next 10 years. This of course assumes that they focus on stocks and avoid mutual funds, ETFs, and index funds.
Please read on so that you can fully understand why stock selection will be paramount and critically important in order to preserve capital and maximize returns in a secular bear market.
The secular bear follows a secular bull, which lived for a record 25 years until it hit its all time peak for the S&P 500 and the Dow Jones Industrials on Oct. 9, 2007. The birth of a secular bear always coincides with the historical peak of a secular bull. Secular bear and bull markets are a rare breed. Prior to the new 2007 secular bear there have been 14 secular markets including an even number of secular bears and bulls since 1802.
One cannot pin point or observe the births of secular bulls or bears because the trend of the markets need to go down by a certain amount or percentage in the case of a secular bear, or up by a certain amount or percentage in the case of a secular bull, in order to confirm the births. Thus, one could only predict the change from secular bull to secular bear months or even years after the change occurred. Secular bull and bear markets by definition last a minimum of eight years and have gone on for as many as 25 years. A secular bear would be marked by an extended long-term period of time in which the major indices of the stock market are unable to get above their highest historical peak. A secular bull would be marked by an extended period of time in which the major indices of the market would be able to consistently make new historical highs.
As you can see in the table above each secular bear is followed by a secular bull. The average secular bear has lasted 13.2 years and the average secular bull has lasted 15.3 years. The minimum duration of a secular bear or a secular bull has been eight years and the maximum duration of a secular bear has been 20 years. The maximum age for a secular bull has been 25 years and that was for the one that just ended in 2007. The overall annualized returns for secular bulls have averaged 13.2% for the past 205 years and for secular bears the returns were 0.3%. Another point that cannot be overemphasized is that the US stock market has performed in waves over the last 206 years. Long periods of secular bears that have averaged per annum returns of 0.3% are followed by long periods of secular bulls that have averaged annual returns of 13.2%. If you average the waves the average annual return over the last 206 years has been approximately 6.3% and this is slightly above the long-term rate of inflation.
Social, political and economic changes within a society are the three major contributors to the change in a secular market from a bull to a bear or vice versa. For example, a country, which was changing politically from a dictatorship to a democracy, would have the impetus to give life to a secular bull and kill a secular bear. The current secular bear is extremely vicious and especially dangerous because it involves changes for all three of the areas that would give life to the secular bear. This secular bear is being fed by changes in the economy. Those changes involve a de-leveraging or the contraction of credit for consumers and corporations. This contrasts with the expansionary credit policies that were in place and in which consumers and corporations were dependent on during the secular bull.
The U.S. and global economies have been dependent on credit growth, credit availability and cheap credit for more than a decade. It would be imprudent for one to conclude that a change from credit expansion to credit contraction and de-leveraging would not have a negative impact on any economy. Therefore, the shift from credit expansion to contraction would be enough to justify the emergence of a new secular bear market.
A change in politics alone can signal a secular change in the stock market. President elect Obama, a decided liberal was the first Democrat since Jimmy Carter to win over 50% of the total votes cast in a Presidential election. The Global Financial Crisis has all but nationalized the U.S. banking Industry. The roots of the new secular bear are also based in a social trend that has dominated the U.S. since 1946. The trend is the Baby Boom of 1946 to 1964. During this 18 year period the peak year for the number of babies born in the U.S. reached 4.3 million, which was an increase of over 50% as compared to the peak year for the previous 15 year period beginning in 1930 and ending in 1945. The baby boomers and their parents ushered in supermarkets, converted savers to consumers and drove the efficient manufacturing and marketing of consumer products such as frozen TV dinners and consumer electronic products such as the television and the transistor radio. This period in which the significant increase in annual birth rates coincided with the efficiencies in the manufacturing and distribution of consumer products resulted in robust sales and earnings growth for public companies. This resulted in averaged annual returns for the stock market of 14.1%.
In 1966, when the oldest baby boomers were 20 years old the 17 year secular bull died and it was replaced by a new secular bear. This change was because of social and economic reasons. When the oldest baby boomers became 20 years old, it became a priority for them to become educated and trained so that they could become productive members of society. Therefore, there were significant costs to train them and a ramp up time before they could all become productive. The bulge of the baby boomers entering the work force in the late 1960’s and 1970s generated high unemployment because there were more of them than there were jobs to fill. They also were the root cause of inflation in the late 1970s and early 1980s as society and the economy were not prepared to handle this huge influx of new consumers.
In 1982, when the oldest baby boomers were 36 and the youngest were 18 years old the old secular bear died. In its place was a brand new secular bull. The bull was driven by the baby boomers who were now educated and they had been assimilated into the work place. They were now the driving productive force behind the economy and a 25 year secular bull. They contributed heavily into their 401K retirement accounts and created a nation of 90 million mutual fund holders. The mutual fund industry had its greatest growth ever during this 25 year period of 1982 through 2007.
It’s important to understand that both secular bulls and bears are inevitable and that a secular bull is followed by nothing other than a secular bear and vice versa. The reason why I believe that the most recent secular bull lived five years longer than any other secular bull over the past 200 years is because the U.S. government decided to inflate the real estate bubble to compensate for the pain in the economy which was caused by the bursting of the dot com bubble. The bursting of the dot com bubble and the events of 9-11-01 should have allowed the 19 year old secular bull to die in its sleep. However, easy credit extended the life of the secular bull to 2007.
Changing economic and social issues are the primary drivers of the new secular bear market, which began in 2007. The big change for the economy is that credit policies and availability will be changing from an expansion of credit, which occurred during the secular bull to credit contraction. I believe that this economic change will cause lower growth in Gross Domestic Production (GDP) for the next 10 to 15 years as compared to the growth rates over the last 10 to 15 years.
The big social change that is driving this new secular bear is that the oldest baby boomers are now 63 years old and are now preparing for retirement. This means that for every year for the next 18 years more and more of the 76 million baby boomers will be redeeming or liquidating mutual funds so that they can meet their retirement living expenses. This is a stark contrast to the last 18 years in which a majority of the baby boomers religiously set aside a portion of their salaries for their retirement accounts. Now instead of having a tailwind of baby boom buyers of mutual fund shares the stock market is facing a headwind, which will increase significantly over the 20 years as baby boomers become net sellers.
Here are several other reasons why I believe that a secular bear was born in 2007 and why it could prove to be the nastiest of all secular bears over the next eight to twenty years:
- Banking consolidation is now underway in the United States. The government with their $700 billion tarp has taken great measures to insure that banks will not be allowed to continue their ridiculous speculation on real estate. New policies, regulation and the lack of capital will result in thousands of local and regional banks in the U.S. being forced out of business. I predict that within less than five years the total number of banks in the U.S., which are insured by the FDIC, will decline from the current 8,500 to less than 1,000. The banking consolidation will put tremendous pressure on real estate prices and also on local and regional businesses as they are denied credit.
- Consumers have begun to pay off debts and spending is decreasing. For the third quarter of 2008, consumer spending decreased by 3.1%. This was the largest decline in the reading since 1980 and it is a bad omen for the U.S. economy since consumer spending accounts for approximately 70% of Gross Domestic Production (GDP).
- Mutual funds are now experiencing redemptions and this is only the beginning. In September 2008, mutual funds had $75 billion in redemptions and this was three times the record, which was set in 2001. For the one week ended October 12th, $65 billion in funds were redeemed. I project that the total redemptions for October and November of 2008 could be approximately $300 billion. Trim Tabs, which monitors mutual fund outflows and inflows has indicated that the recent redemptions are different than what they have monitored in the past because mutual fund holders are pulling their monies out of mutual funds altogether instead of switching or rotating to a different fund.
- The residential real estate market is unlikely to recover. Residential real estate will likely remain in a long-term secular bear market. Banking consolidation is one factor. The second is that the $700 billion bailout was originally intended to be used by the U.S. government to purchase and hold toxic mortgages. Now that the bailout money is being diverted to the purchase of preferred equity to shore up U.S. banks and financial institutions the monies will not be available to purchase the mortgages. The likely result will be a wholesale liquidation of mortgages. This will drive down the prices of homes. Also, there are currently 12 million houses that have mortgages that exceed the value of homes and it’s expected that 30% of all mortgages will have outstanding amounts that are greater than the value of their underlying homes by the end of 2009.
- The recession. The first global recession in more than 30 years is underway. While some are optimistic that it will be over by the second quarter of 2009, this recession could prove to be long and deep. Since this recession could put plenty of pressure on the economies of the U.S.’s trading partners and G7 I believe that the result could be a very strong dollar which could hamper the U.S.’s recovery. Should the dollar mount a sustained advance against the Euro, the recession could last longer than expected. This could result in the U.S. being among the last countries to come out of the recession.
- The Global Financial Crisis has made it difficult to value all asset classes for the first time since 1929. For the first time since 1929 it is difficult to value all four asset classes which include commodities, bonds, real estate and stocks. In all other stock market related financial crises, with the exception the crash of 1929, there has always been some price stability for hard assets such as real estate or other assets such as oil and commodities, etc.
The crash of 1980 is a good one to make a point because it was the one in which I was intimately involved. It was caused by two brothers, Nelson and Bunker Hunt, who were members of one of America’s wealthiest oil families. The brothers concocted a scheme to corner the silver market and in doing so drove the price of silver from $11.00 to $50.00 an ounce. Despite their efforts they were unable to maintain the lofty price levels and the price of silver broke and went all the way back to $11.00 per ounce.
What caused the ensuing crash of the stock market in the spring of 1980 is that the brothers had borrowed funds from their margin account to purchase the silver. They used their Wall Street Stock Brokerage firm, Bache Securities, to finance their purchases of silver. When the price of silver broke they got a humungous margin call from Bache and they were unable to meet it. The margin call put Bache in a precarious position and Prudential Insurance, the U.S.’s largest insurance company at the time, had to come to the rescue. This resulted in Prudential having to acquire Bache and hence the name was changed to Prudential Bache. Anyway, I suffered collateral damage from the margin call because it just so happened that the brothers’ biggest stock position was Penn Central Corporation. I had been advising my clients to purchase Penn Central shares at $24.00 prior to the crash. When the Hunt’s large silver position hit the market on their forced margin call sales, the sales drove the price of the shares all the way down to $16.00. I got on the phone and told my clients to buy more Penn Central and they listened to me. My argument was that Penn Central had real estate assets in Florida that had been valued at $30.00 per share. Penn Central shares recovered and within 10 days they were right back to $24.00. The moral of this story is that Penn Central had hard assets that were used to value its shares. That is not possible today because of the instability in valuing all asset classes.
The fact that hard assets can not be easily valued makes it difficult to bring “value investors” out of hibernation. Historically, the value investors are the ones who buy stocks at market bottoms, especially those bottoms which are caused by a financial crisis. Because it's hard to value those assets it’s very difficult for value investors to rely on the traditional Price to Book multiple or ratio. Because of this phenomenon there is not a foundation under any of the market indices and therefore this makes it very difficult to predict a bottom for the major indices.
- The U.S. Dollar is strengthening. A flight to the dollar will prolong the recession in the U.S. Foreign investors who are domiciled outside of the U.S. tend move their assets to the US greenback and also the Swiss Franc during periods of political, social or economic instability and uncertainty. Money is moved into Swiss and the U.S. currencies because these two countries respectively have the first and second longest standing democracies in the world. Foreigners know that the Global Financial Crisis will result in political uncertainty in certain parts of the world. That is why the dollar started to skyrocket against the Euro and other currencies in October. A strengthening dollar is a very bad omen for the U.S. economy. This is because the U.S. economy and the growth of revenue and profit for the U.S. global multinational corporations have been dependent on a weak dollar to drive exports. Now, the predicament is that the worse the global economy gets, the higher the dollar will go against most other currencies. A strong dollar will raise the prices of U.S. Goods and services to foreigners. This could result in a deepening or a prolonging of the recession in the U.S. A strengthening U.S. Dollar is also bad for the economies of most South American countries and China because their currencies are pegged to the greenback.
Mutual funds and other investment vehicles such as ETFs, etc., that are dependent on the appreciation of the major indices such as the Dow Jones Industrials and the S&P 500 should be completely avoided in a secular bear market. Mutual funds generally produce mediocre and in some cases negative returns in secular bear markets because (1) by their very nature they can not time the market because by their charters they must remain fully invested and (2) it is very difficult for them to maneuver when they are under the siege of steady or constant redemptions. In a secular bull it is easy for a mutual fund manager to produce consistent positive annual returns because they can use the fresh inflows of cash in order to average down so that they can take advantage of market dips. For example, in a secular bull market a mutual fund manager could use his or her available cash to take advantage of a dip in the market to average down their position in IBM from $100 per share to $90 by purchasing an equal number of shares at $80. A money manager in a secular bear does not have that same luxury. He or she is forced to sell their positions and take losses with the market down because they face steady redemptions. Stock selection is critical in a secular bear market. Unlike a secular bull market, investors must have the discipline to avoid those companies, which had the highest concentration of institutional ownership at the peak of the secular bull. The reason why the most popular institutional stocks in a secular bull must be avoided during a secular bear is because they will likely bear the brunt of redemptions. This means that those share prices, of these companies with high concentrations of institutional ownership, will likely be under constant pressure as fund managers will be forced to sell the shares because of redemptions. Therefore, the shares of companies such as General Electric ( NYSE:GE) should be avoided. At last count GE had 1,712 institutional investors who owned 58% of its outstanding shares. To put this into perspective, should all those fund managers line up to sell their GE positions, to make their redemptions it would take them approximately seven years to do so assuming that one manager per day were able to sell.
It’s important to understand that at the top of a secular bull market, stocks go from strong to weak hands, and at a secular bear market bottom, shares go from weak to strong hands. It takes courage, discipline and conviction to purchase stocks at a secular bear market bottom when few want them. On the other hand, those who normally buy at secular bull market tops do so because they are driven by emotion instead of being driven by value.
Conservative or disciplined investors should not run and hide from a secular bear. They should embrace it because a secular bear provides extraordinary opportunities for investors. Many high quality stocks will trade at 10 to 20 year lows when the secular bear makes a bottom. Additionally, investors should be looking for and investing in “emerging” growth stocks and growth industries in a secular bear market. Emerging growth stocks are very desirable for two reasons. The first reason is because they are (1) the new and upcoming companies, which are among the fastest growing in the economy. Even more importantly (2) they generally have little or few institutions or mutual funds, which hold their shares.
One industry or sector that I expect to perform well in a secular bear is the financial media and online financial information industry or sector. This is for several reasons:
- The financial media industry or the online financial sector is the only one out of the 216, covered by StockDiagnostics.com, which is directly benefiting from the Global Financial Crisis. CNBC’s viewership in October of 2008 soared by 97% over October of 2007. The shares of industry member Bankrate, Inc., (NASDAQ:RATE) which is the single largest provider of online information for mortgage rates and savings rates increased by 23% on October 31st after the company reported its earnings for its third quarter ended September 30, 2008. The following is a quote from Bankrates’ CEO that I pulled from its October 30, 2008, press release: "In a historically volatile time for financial service companies, we have turned in a record quarter. The company has benefited from our ability to monetize the strong traffic we've seen as consumers are looking for help and advice in this turbulent economic environment". Thomas R. Evans, President & CEO, Bankrate.com
- There are 90 million individuals in the U.S. who held mutual funds at the end of 2007. With the recent downturn in stock prices practically all of them are saddled with significant paper losses and poor returns. For the first time ever many of them will switch from being passive mutual holders to active stock investors. They will have no choice if they want to preserve their capital and increase the value of their portfolios during what could prove to be a very long secular bear market. This change will result in booms for those companies, which provide online investor services such as online education, online information and online brokerage capabilities.
- Another major reason why I believe that the financial media and online financial information industries or sector will be one of the best for secular growth during the secular bear is because there are few investment professionals who have the experience which would enable them to guide 90 million mutual fund holders through the new secular bear market. When I joined Merrill Lynch in 1977, I was hired to be a stockbroker. My training emphasized stock selection. The secular bull, which was born in 1982 all but eliminated this type of training. Instead the Financial Services Industry was born and it replaced the stockbroker with a financial advisor. Those advisors were trained in asset allocation (mutual fund diversification strategies) and they were not trained in stock selection. Therefore, the U.S. has an entire generation of financial advisors and financial planners, which know little about stocks.
The table below contains the companies within the Online Financial Sector and that I am recommending and the reasons why:
For investors to preserve their capital and be successful at investing in the secular bear market, I am recommending that they utilize two online tools. I use both of these tools regularly for my stock picks. The first one is www.StockDiagnostics.com. The web site provides easy to use proprietary charts, which enable an investor to monitor and track cash flow for approximately 8,000 publicly traded companies. This is the tool that I used to make a lot of my bold predictions over the last six years including the bankruptcies of many large public companies. To view my top ten calls go to www.onlinefinancialsector.com.
It is imperative that any investor who has capital in the stock market gain access to StockDiagnostics.com. According to my most recent data 2,961 public companies or 37% of all public companies trading in the U.S. had negative cash flow over their most recent 12 months. Many of these public companies will go out of business before this secular bear has run its course because they will find it very difficult to obtain the credit that they need to fund their negative cash flow. During a secular bull market, especially the most recent one because it was driven by easy credit, its fairly easy for companies to borrow in order to fund their negative cash flow. This is exactly the opposite case in a secular bear.
Crocs, Inc., (NASDAQ:CROX) the manufacturer of the popular rubber shoes is a good example on why its critical that investors subscribe to StockDiagnostics.com. I am using Crocs as an example because, many investors have been advised by market mavens, such as Peter Lynch and Warren Buffet, that they should own the stocks of the companies in which they buy products. Crocs, who has millions of consumer, which have purchased its shoes has certainly been one of the most popular consumer products companies. On November 19, 2007, Crocs’ OPS Ranking was downgraded by StockDiagnostics.com after its free cash flow indicated that it generated a negative $.15 per share for its third quarter of 2007 as compared to positive free cash flow of $.21 per share for its year earlier same quarter. At the time of the downgrade Crocs’ shares were at $38.00. StockDiagnostics.com subsequently downgraded Crocs shares to lower rankings on both March 3, 2008, and on May 27, 2008. Crocs shares hit a new 52 week low of $1.66 in October 2008. Based on the fact that Crocs has generated a cumulative negative free cash flow of $60 million since 2006, I strongly believe that it will be one of the casualties of this secular bear. I also use StockDiagnostics.com for picking stocks that are going to significantly outperform the market. In my June 2007, article “The Party is Over”, in Equities Magazine I told readers to get out of Amazon, Yahoo and Ebay and to invest their monies into Priceline.com. My recommendation was based on the fact that the cash flow growth for the big three web companies had slowed considerably and that on the other hand Priceline’s cash flow was accelerating rapidly. Between June of 2007 and June of 2008, Priceline’s shares increased by over 70% and the share prices of the other three were only able to maintain their status quo.
Another “must” tool or web site that investors need access to in order to cope with the new secular bear is www.shareholderdiagnostics.com. This web site, which I designed provides comprehensive information on the shareholders of each public company. The site includes proprietary charts, data and information on institutional shareholders, insider buys and sells and short interest. The worst companies to own during a secular bear market are those that have a high concentration of institutional ownership. Conversely, the best to own are those that have few institutional shareholders. The site gives you easy access to this type of information.
As I stated earlier in this article my prediction is that the S&P 500 will eventually go to at least 547.75 and that the Dow Jones Industrials will eventually find its way to 5665 or below. These two numbers were calculated by making the assumption that the S&P 500 will trade down to the equivalent of 65% below its peak that it made on October 9, 2007. My calculation for the Dow assumes that it will trade down to the equivalent of 60% off of its peak. These calculations were based on the following assumptions:
- When the NASDAQ Composite hit bottom in 2002 it was trading at the equivalent of 79% off of its all time high, which it hit in the spring of 2000. Given that the Global Financial Crisis makes the dot com bubble look like a non event it is not far fetched to believe that the Dow and the S&P will trade to levels which are equivalent to at least 60% and 65% off of their historic all time highs. The NASDAQ peaked in the first quarter of 2000 and the index is still approximately 70% below its all time highs.
- I am more optimistic about the Dow’s bottom because I believe; (1) That foreigners will utilize the giant blue chip Dow names as a safe haven to invest dollars instead of purchasing other dollar denominated bonds and shares. (2) The 30 members of the giant blue chip index are more likely to maintain their dividend payouts.
- The S&P 500 is loaded with financials. I expect that they will significantly under perform for the big index. Also, the S&P 500 has a much higher number of members, who do not pay dividends. Therefore, the index will not have the yield support that the Dow will have.
For more and continuing information on the secular bear market I suggest a visit to my new free web site, www.BearMarketNavigator.com. The site has an automated slide show on the secular bear and other information that will enable investors to become fully educated. The site also has a Bear Market Guide, which provides safeguards for investors to follow so that they can preserve capital and make money in a secular bear market. I also will continue to post information on the secular bear market on my blog, which can be found at www.equitiesmagazine.com.
The stock market still has too many unknowns including a major one, which is the recession and how deep it will be and how long it will last. Because the major indices are still subject to much peril, I am reiterating my conservative capital preservation strategy. Investors should use the recent strength in the market to liquidate their mutual funds and stock holdings. They should invest 80% of their liquid assets in US Government short-term securities. The remaining 20% of their assets should be invested in public companies that participate in the financial media and online financial information sector of the economy. For more information on the online financial sector I suggest that you check out www.onlinefinancialsector.com.
Michael Markowski and/or his family members hold shares in each of the companies that he is recommending in this article and may buy or sell such shares at anytime.
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