The giant bear-market rally that began in March 2009 is almost certainly over, according to market indicators. It was an impressive affair, to be sure. America’s S&P 500 index rose 83 per cent in 13 months. Given the strength and duration of these gains, many investors understandably mistook it for a genuine bull market. But I believe it had more in common with the spectacular leaps that have punctuated Japan’s 21-year-long bear market.
One reason I never believed that the 2009-10 rally was the real deal was because trading volumes generally shrivelled as the market rose. I can find no precedent for this behaviour in US stock-market history. In a major bull market, the number of shares dealt ought to increase as the index pushes higher. Contracting volumes, by contrast, denote a lack of conviction on the part of investors, and therefore a trend that is not sustainable.
Although the S&P 500 peaked in late April, proper confirmation arrived only last week. First, the Coppock curve – a long-term momentum indicator – rolled over negatively. While the Coppock curve is most widely used for signalling early-stage bull-markets, it has a decent record of calling bear markets too – including that of the Great Depression and the bursting of the 1990s tech bubble.
Next, we got a Dow-Theory sell-signal. The Dow Theory is one of the oldest and most venerable methods of determining the stock market’s outlook, and is based on the insight that the movements of the Dow Jones Industrial Average and the Dow Jones Transportation Average ought to confirm one another. It warned us to sell up on June 30 when both indices fell through their previous lows of that month.
However, rather than marking a new bear market, I believe the latest downtrend is merely the continuation of the long-term or “secular” bear market that began back in 2000. Although equities have historically been the best-performing asset class, they can also languish for extended periods. There were three such “lost eras” in the 20th century. Comparing today’s situation with those previous phases – as well as to Japan more recently – provides some important clues about the future.
The secular bear markets in my study typically destroyed around three-quarters of the stock market’s real value. It generally took about 20 years from their peak for equities to begin a sustained recovery. But, at their lowest point since 2000, US stocks had lost only about half their inflation-adjusted value. And at that stage, the latest lost era had lasted just over nine years.
Of course, it is possible that “this time is different” and that the secular bear market has already run its course. If anything, though, today’s lost era ought to be deeper and longer-lasting than previous episodes. Valuation is the reason. Previous lost eras began with the dividend yield on US stocks at 3.4 per cent and ended when it was higher than 5 per cent. But even at their cheapest level of the last decade, US equities still yielded a mere 3.37 per cent – slightly below where they started previous secular bear markets!
The next phase of today’s secular bear market should ultimately see the S&P 500 – as well as other Western markets – revisit and drop below their lows of 2003 and 2009. If I am correct and the S&P breaches 666, there is precious little to break its fall on the chart until 475-450, and thereafter 429.
My analysis of time factors has highlighted some possible turning-points. Particularly heavy selling could occur from October 2011 and into 2012, as the three main long-term cycles in the stock market will all be in downward mode by then. Those same cycles also imply the possibility of a major bottom occurring around October 2012.
As with all bear markets, there will be further decent rallies along the way, many stronger than the type that usually occurs under bullish conditions. These deceive investors into thinking that the indices have bottomed and that the good times are here again. Cycle-analysis makes me believe that the S&P should enjoy a rally from mid- to late July well into August at least. As this move expires, it will prove an excellent opportunity to unload holdings and enter short positions.
Can equities elsewhere buck the trend of the most influential stock market in the world? Previous experience would suggest not. Investors should therefore be wary of fund-managers peddling stories of emerging markets “de-coupling” from the developed world. Although emerging markets have undoubted appeal in the long run, there will be much better chances to buy into this area.
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