It’s Not Different this Time

I.C. Angles Investment Post…

To believe that the stock market will rise significantly from its recent August highs, when the S&P 500 reached over 1,700 points or not revisit near its lows, is to bet that it is different this time. The famous declaration of legendary investor, Sir John Templeton, that, “The four most dangerous words in investing are, it’s different this time” has over the past few months become particularly pertinent. The secular bear market that began in 2000 (when investors believed it was different that time and the Internet had fundamentally changed the nature of the stock market removing the risk of a major bear market) would need to have ended in the 2009 bottom for the stock market to now rise significantly higher or not fall to around previous lows. But there is little reason to believe this time is different, that stocks entered a new secular bull market in 2009, well below the typical duration of a secular bear market and that the odds now favor a heavy allocation to stocks.

A Case for Cash

In my view now is a good time to hold a significant cash position. Bullish expectations that it is different this time and the stock market has entered a new secular bull market, where the risks of a major bear market have been mitigated by the willingness of central banks to prop up stocks with cheap money, are likely to prove dangerously mistaken. I’ve been clear in my previous posts of my expectation of the worst still to come, with another major bear market still in store for this secular bear market. If you don’t have time to read all those posts a nice summary of several of my key points, as well as some good original insights on the nature of secular bear markets that is worth a read is Vitaly Katsenelson’s “Are We There Yet?” article. Suffice it to say, my strong expectation is that there will be a future opportunity to deploy cash to buy stocks well below current August 2013 price levels.

Secular bear markets tend to last over 15 years, experiencing multiple cyclical market moves. The previous secular bear market of 1965-1982 lasted 17 years and experienced five bull and bear market cycles. The S&P 500 tended to peak in the range of 1,000 points, similar to how this secular bull market has so far tended to peak around 1,600 points. For comparison the third cyclical bull market peak of 1973 was the highest of the five staging a false breakout above that 1,000 point level, similar to today’s bull market move above the 1,600 point level after the 2000 and 2007 markets were unable to break above. However, if the stock market is still in a secular bear market it will not be able to sustain a move significantly higher or not recede to near or below previous lows.

For this secular bear market to have ended in about a decade would mean it is the shortest one in over a century and that this time is indeed different. There is little reason for such optimism. As I argued in my post the “Party it Over” I believe the stock market is severely overestimating the ability of central banks to intervene and suppress interest rates and support the stock market or economy. Since that June post the argument against faith in quantitative easing has only been strengthened by among other things a paper from the Federal Reserve itself documenting how little impact the mechanics of quantitative easing actually has on the economy, as well as the increase in interest rates, as the dollar carry trade in emerging markets has begun to unwind, with countries being forced to sell from stockpiles of Treasuries to defend their currencies.

Odds Stacked Against Stocks

There are no certainties in the market, and stocks could go higher for longer. However, the risks of owning stocks now outweigh the potential rewards. Since secular bear and bull markets both last almost two decades the fact is that over a century of history really isn’t that much. There are just two previous secular bear markets and three secular bull markets. So, the possibility that this time is different needs to be seriously considered. Unfortunately, the facts support the view that stocks remain in a secular bear market that will eventually see the market fall well below today’s levels–a buying opportunity for those with cash and a gut wrenching ride for those heavily allocated to stocks.

Consider for a moment that the labor workforce participation rate is at a 34-year low of 63.4 percent. This is not the stuff of secular bull markets, but rather damming evidence the stock market remains deep in a secular bear market, despite being near its all time highs. The secular bull market that began in 1942 saw Franklin Roosevelt calling for men to fight and women to join the war effort in a full-employment wartime economy. The secular bull market that began in 1982 with a powerful economic recovery would lead to the well known 1984 ‘It’s Morning in America’ political campaign of Ronald Reagan. Conversely, more than 15 percent of Americans on food stamps and an exceptionally weak economic recovery is far more indicative of the breadlines of the secular bear market in the Great Depression than a secular bull market. Now it’s not my intention to praise FDR or Reagan, a Democrat and a Republican, or disparage Obama, but to simply point out this current economy is not the stuff of a new era of prosperity, experienced in secular bull markets.

Risks Not Priced In

The risks that we remain in a secular bear market and potential drivers of the next major cyclical move down are not priced in at current stock market levels. In my view such risks include: unwinding of the dollar carry trade with foreign countries selling dollar reserves; inability of central banks to impact interest rates or support the economy upon a loss of credibility; the United States entering the stage of its presidential cycle with the most historical stock market risk; economic hard landing in China with reverberating impacts on Asia, commodities and commodity-linked industries and countries; rising threat of global conflicts; and unresolved structural issues in the Eurozone. Smart people can also debate the risk of a stock market crash, given the dynamics of high frequency trading, record margin that includes leveraged ETF vehicles, and the potential for a spike in interest rates.

All in all it’s a strong argument that this time isn’t different and carrying some cash isn’t a bad idea, even if this stock market doesn’t immediately roll over into another cyclical bear market. The very real risks and likely rewards are just too lopsided for an aggressive stock allocation.


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