Past Market Views - The Past is Prologue

AAMG's Past Market Views
The Past is Prologue

What’s up with this market? This is the question most often asked when a market trades in a narrow range for an extended period of time, as we have seen this year. There is no real answer to this question, only guesses. The question reminds me of an article that we wrote over three years ago entitled, “Those That Ignore The Past Are Doomed To Repeat It.”

As was said in that piece, no one can guarantee anything in any market. As students of the market, and those charged with investing other people’s money, we must look back in time and compare similar periods to see what lessons we can learn and how we can take advantage of them to make money. This we will try to do here.

From our studies, we have concluded that we are in a secular bear market that was born in January of 2000. From studying past secular bull and bear markets, we have found that there are cycles that move in the opposite direction to the secular trend. As an example, in the last secular bear market from 1966 to 1981; there were four reversals to cycle bull markets within the secular bear. In the secular bull market of 1982 through year-end 1999, there were only two years where the Dow Industrials ended the year with a loss. Since we are in a secular bear market let us see what we have learned from the past. We know from the research done by Crestmont Research in their study entitled “Secular Bull and Bear Markets Profile”, that of nine secular movements, four were bull markets and five were bear markets. The longest in duration was the bull market of 1942 to 1965 and the two shortest, one bear (1928-1932) and one bull (1933-1936) were only four years long. On average bears roamed Wall Street for a little over eleven years. However, the last bear lasted sixteen, but there were opportunities galore to profit during the four bull cycles imbedded within that period. Interesting to note that during that secular bear market the Dow equaled or exceeded the high of 1966, the first year of the bear market several times. On a yearly basis, the market showed many double-digit losses, yet the Dow showed only about a 10% loss for the total secular bear market. Therefore, these type markets become a stock picker’s market, not a buy and hold market.

Market history has also taught us two additional things. First, PE ratios always narrow during a secular bear market and second, CPI inflation figures always expand. It we look back at the two longest bear markets, 1901 – 1920 and 1966 – 1981, we find that in the first, the PE decreased from 23 times to 5 times while the CPI index went from –2% to 16%. In the second, the PE stood at 21 times in 1966 and dropped to 9 times in 1981 while the CPI was at 3% at the start of the period and ended at 10%. Obviously there is much to learn from studying the past. Applying it to our advantage becomes the real challenge.

This becomes important because as we look at our present situation we find many many simulator patterns between the past and the present. The first bear market of the past century started with three down years followed by two up years. A high, double digit PE gave way to very low ones in the 20th and last year of the bear. In the market from 1966 to 1981, the same thing happened. In both markets, the inflation rate started at a low rate and increased, as the market got “longer in the tooth.”

We are in the sixth year of this secular trend. The first three years were down with the third year reaching the low water mark up to now. Then the next two were up, but only recaptured about 70% of the total 2000 to 2002 decline. Here in the sixth year all the indexes are up, but just by a few percentage points, yet may not have the strength to keep them in positive territory for year-end.

So where are we, and how do we invest in this kind of a market? Reaching back in time, the first cycle was down and ended in 2002. The first reverse cycle, a bull cycle, started before year-end of 2002 and began to fizzle into a trading range early in 2005. So we know that the DJIA is at or past the top and headed down for the second bear cycle within the secular bear. That answers the “where” question; now for the “how”.

Here is where the reader is going to have to do his/her homework. What have been the strong sectors in this first bull cycle? Will they continue to be bullish during a down move? There are sectors and individual stocks that will move counter to the primary trend; you just have to search them out. A clue to this mystery can be found in a recent published book entitled The World Is Flat by Thomas L. Friedman of “New York Times” fame and published by Farr, Straus and Giroux. Friedman tells his readers about the global supply chain and all about future services and manufacturing. This is paramount if an investor is to match investment opportunities to where these goods and services are coming from in this flatting global environment.

Gordon B. Lamb
October 31, 2005

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