Planning to Avoid the Secular Bear Market Trap

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A carpenter’s house is never finished. A plumber’s tap leaks. Does a financial planner have a financial plan? This planner does.

To paraphrase Woody Allen, ‘If you want to make the investment industry laugh, tell them about your plans.’ At the risk of derision by my planning peers, I will share my unorthodox plan with you.

My plan does not conform to traditional financial planning theory. Challenging the industry’s beliefs leaves me wide open to ridicule and potential humiliation. Also, an honest opinion in the institutional world is not always appreciated.

The Method in My Madness

Standing on Cape Byron (Australia’s most easterly point) offers you a wonderful vantage point to observe the rhythmic pattern of the ocean. Waves begin to form around the headland and gradually crest and fall on the beaches of Byron Bay.

You note the build-up of each wave takes far longer than the crash. Some days the waves are higher or choppier than others, but the pattern is repeated with an almost hypnotic monotony.

The ocean and markets are very alike. Patterns and waves are clearly evident in the long-term charts — major build-ups eventually cresting and crashing.

A panoramic view of the US share market — stretching back over 130 years — provides a wider perspective on the emotional waves that have formed and crashed on the world’s largest market.

No two waves are identical, but they exhibit a similar pattern — undervaluation to over-valuation and back again. Mathematical reference points — indices, PE ratios etc. — measure the market’s ebbs and flows.

On a more basic level the market’s wave patterns are a reflection of social mood. Optimism creates the crest of the wave — the more extreme the optimism, the higher the wave (and the higher the PE multiple).

1999 was a perfect example of extreme optimism. The Cold War was a distant memory. The tech boom had created ‘paper wealth’ and a world of possibilities. Credit was freely available. The S&P 500 index was priced on a PE of 45 (double the PE high point of previous market booms). The song ‘Party Like It’s 1999’ was very appropriate.

The 2000 ‘tech wreck’ and 9/11 removed the alcohol from the party. The change in social mood was reflected in the market’s retracement.

Secular Bull Markets begin with extreme pessimism (low PE) and end with extreme optimism (high PE). Conversely, Secular Bear Markets start with extreme optimism (high PE) and finish with extreme pessimism (low PE).

‘Recentism’ explains why this mood change takes a decade or longer to manifest itself. Our recent experiences form the basis of our future expectations — a rising market will continue rising and a falling market will continue falling. Altering that perception takes time.

Secular (long-term) markets gradually condition the investor to think the pattern (up, down or sideways) will continue. Secular Bear Markets historically grind investor expectations to dust — dreams of promised share market wealth are shattered. Ultra low (single figure) PE’s reflect this despair.

From the vantage point of history, the Secular Bear Market wave that started in the US in 2000 is still gathering in intensity. With the aid of central bankers it is in the process of cresting. Even someone with Kelly Slater’s ability would consider this wave dangerous, yet anyone with a boogie board is being encouraged (or forced) to enter the water.

Knowing the limit of my skills means I’m opting to stay on the shore and not join in the fun.

This is where I differ from the majority of the investment industry. The Secular Bull Market conditioned the industry to think you must always be in the market — irrespective of the weather forecast or shark sightings.

The central bankers are trying to convince investors they have created a wave park — with perfectly controlled conditions.

Hurricane Katrina showed us the contempt nature had for New Orleans’ man-made levees.

For now the market is indulging the central bankers delusions of grandeur — toying with them and letting them think they are more powerful than the forces of nature. When the market decides to unleash its fury, these charlatans will be publicly vilified

Model Portfolio


Asset Class

Preferred Allocation %

Reason for inclusion

Cash/ Fixed Interest

20%

Security and liquidity

Listed Property Trust

20%

Income and inflation protection

Australian Shares

20%

Tax effective income and capital gain (inflation protection)

Emerging and Frontier Markets

20%

Capital growth (inflation protection) from developing economies unencumbered with debt, welfare and healthcare commitments

Precious metals

20%

Inflation hedge against excessive money printing

The model portfolio has been designed to protect and prosper from the big picture view. Which is:

  • The forces of The Great Credit Contraction (debt repayment or default) will continue to exert a deflationary influence on the global economy. During this phase ‘Cash is King’.
  • Policy makers are attempting to fill the void created by the ‘borrow and spend’ withdrawal of the private sector with increased deficit spending financed by Quantitative Easing. There are longer-term inflationary implications from the world’s central bankers adding significantly to the global money supply (as per #5). At present the rate of money flowing through the economy has slowed significantly due to the repayment/default of debt trumping consumer spending.
  • In the near term (next 1–2 years), as the global economy weakens, Australian cash rates could possibly fall into the sub-2% range.
  • Global share markets are currently being supported by artificial means — zero interest rates and QE programs. If share markets follow previous secular bear markets, valuations are destined to fall significantly, representing a better buying opportunity for cashed up investors.
  • Unlimited and indefinite QE has the probability of unleashing inflationary forces later this decade. The rate of money flow in the economy may well gain speed as people realize the buying power of their cash is being eroded and scramble to buy ‘things’.
  • Higher inflation erodes the buying power of cash. At some point funds will need to be switched from the ‘safety’ of cash to the inflation protection offered by hard assets — property and precious metals. This transfer needs to be in place before the herd awakens to the inflationary forces embedded in the economy.

Current Portfolio Mix


Asset Class

Preferred Allocation %

Reason for current allocation

Cash/ Fixed Interest

100%

Security, liquidity and current rates still offer a fair return of 4.0% to 5.0%.

 

Listed Property Trust

0%

This sector is still working through its debt issues. Also any share market downturn will impact unit prices negatively and represent a better buying opportunity.

Australian Shares

0%

Do not believe markets are standing on their own two feet too much central bank intervention. Anticipate a fall of 50+% in next 2–3 years.

Emerging and Frontier Markets

0%

While these markets offer solid long-term gains they will be adversely affected by any major downturn in western world markets.

Precious metals

0%

Watching this sector closely for a staged buy in. Independent research indicates further sell off in precious metals may materialise in the event of a major economic upheaval e.g. GFC Mark 2.

Are Things Going to Plan?

Obviously I have missed the market’s ‘recovery’ from its 2009 lows. This does not faze me. Previous Secular Bear Markets show better (and more lasting) buying opportunities await. This prudent approach can be frustrating.

Most male baby boomers would have grown up with the TV series Kung Fu (David Carradine played a Shaolin monk). In a Secular Bear Market, Master Po’s (Carradine’s mentor) advice to boomer investors would be ‘Patience grasshopper, patience.’

Just as the weather couldn’t care less about your expensive holiday plans, the market has absolutely no regard for your investment timeframe and desired rate of return. The market will do what it has to do in its own sweet time. You must remain patient.

Secular Bear Markets are destructive. Investors who think they can defy the odds are risking the same fate as those who drive through a swollen river. Sometimes you just have to wait, irrespective of what your plans are. Japanese investors know this only too well. For two decades their share market fell 80% in value — try telling them it is ‘time in the market, not timing the market’.

So on balance my plan is going well and the pieces of the puzzle are gradually falling into place.

The Great Credit Contraction appears to be winning the arm wrestle. The recent manufacturing indices for China and the US show a dip below the magic 50 mark. In spite of all the printed money over the past four years, the underlying global economy is still weak. China’s contraction means this weakness is now on our shores.

Eventually fact trumps fiction. When the disconnect between markets and the economy is no longer able to hide in the shadows of ‘doctored’ data, all hell will break out on markets.

If it takes another five years for the Secular Bear Market to reduce the market to a single digit PE, then so be it.

The Secular Bear Market’s job is to correct the excesses in the economy. By deferring this cleansing process, the central bankers have only increased the pressure in the system. The fury from the impending storm will deter a generation of bathers (investors) from ever setting foot in the ocean (market) again.

Now that I have laid bare my deepest concerns and my plan of defence, the laughter you hear is from my peers. ‘Chicken Little’ perhaps. But given the stakes, I prefer to see myself as being a little chicken rather than full of mindless bravado.

Regards,

Vern Gowdie
for The Daily Reckoning Australia

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From the Archives…

Why You Should Keep Your Portfolio Grounded in Cash
31-05-13 – Vern Gowdie

China’s City in the Sky
30-05-13 – Dan Denning

House Prices First, Stocks Second.
29-05-13 ­– Dan Denning

Why Natural Gas Could be the Next Crucial Industry for Australia
28-05-13 – Dan Denning

The Japan’s Nikkei is Starting to Crack
27-05-13 – Dan Denning

Vern Gowdie

Vern Gowdie

Vern Gowdie has been involved in financial planning in Australia since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners. His previous firm, Gowdie Financial Planning, was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser magazine as one of the top 5 financial planning firms in Australia. He is a feature contributing editor to The Daily Reckoning and is Founder and Chairman of the Gowdie Family Wealth advisory service and editor of the Gowdie Letter To follow Vern's financial world view more closely you can you can subscribe to The Daily Reckoning for free here.
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4 Comments on "Planning to Avoid the Secular Bear Market Trap"

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Luke
Guest

I see you have the same plan I use :)

jhpace1
Guest
My own portfolio is not, and I cannot recommend, 100% Cash/ Fixed Interest. Inflation is eating you alive! Rates can only go up from here! You can stay liquid by using “ladder” certificates, but that 20% Precious Metals should have been locked away and buried somewhere. Your other portfolio areas are not areas I have invested in personally. I have been recommending to others to do what I have done, fix up my house so it does not need repair for the next 15 years, and buy survivalist equipment and supplies. A can of food will be worth more down… Read more »
Maxwel neville A lpen
Guest
mr Vern gowdie. your own numbers ,2000 top. == 11750. 2007 top. == 14198. and the last hit–31-7-2013. ===15634. this trend line , near perfect target . Another trend line .==1973 == 1987 ==2009 ==perfection friend ==A POWERFUL TREND line. The name Max Alpen may mean nothing to you, so a few Facts. I Developed Southside raw Materials and Nursery in white rock and Supplied to Major developments in Cairns and port Douglas .. Mr Tom pyne’ opened The operation in 1984, and i closed the Buisness in 2008/9 . In my humble way i picked the top in 2007/8,… Read more »
Worker
Guest

You are right about secular bear markets, I believe they will continue in both USA and Australia until about 2020. However unlike the USA the Aussie market is well down on previous peaks and in Australia I would expect shares to rise about 4% pa during this time to get back to 2007 highs, and with dividend yields including franking for blue chips far exceeding cash yields I think Australian shares should be included in a portfolio, cannot say the same about US shares though…

wpDiscuz
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