Would you invest in a secular bear market? You’re probably doing just that this very minute.
Vern Gowdie told the World War D audience what he told a gathering of financial market professionals in 2006. The bull market they think they are in is really just a rally in the midst of a long term secular bear market.
That’s not a religious reference, although his 2006 audience did think he was a heretic. This time around the audience was a little more receptive, given what happened in 2008.
The idea behind Vern’s thinking is that markets move in cycles, just like many other parts of life. Seasons, demographics, politics and the weather (outside of Melbourne) are other examples. Secular cycles are the longer term ones. Secular bull markets can feature many crashes in the midst of stock market prices rising over time. Secular bear markets tend to be long term sideways movements with periodic rallies and crashes.
We’ve been in a secular bear market since 2000. The market has been going sideways overall, despite rallies and crashes. Right now, we’re at all-time highs in the US, with many other countries lagging behind. So is this a new secular bull market, or are we in for another crash as part of the secular bear?
Well, based on past secular bull and bear markets, which follow a fairly consistent pattern, Vern’s answer is that we’ll see at least one more crash. His trigger to invest for the new secular bull will be a P/E ratio of about 10 in the US market. That implies a 60% fall for share prices, depending on how you forecast earnings — the denominator in the ‘Price to Earnings’ ratio.
So, are you up for a 60% crash in the US stock market and what it would do to our own ASX? Vern isn’t. He’s quite happy waiting until after the crash. Then he’ll invest for the new secular bull market at far lower prices.
If you prefer metaphorical reasoning, Vern didn’t disappoint. Showing his Queensland colours, he pointed out that going sailing with Cyclone Yasi on the horizon would obviously be a bad idea. So why invest in the midst of all-time highs during a secular bear market?
It’s especially dangerous because, once you make a loss, it’s damn hard to recover from it. A 60% loss requires a 150% gain just to recover your capital. So if you participate in secular bear markets, you’re gambling wildly on the next bull market being particularly prolific.
Of course, the funds management and brokerage industry you deal with makes its money, not from bull markets, but from being in the market at all. So their plug will always be the coming profits you can make.
Without the same incentive structure, Vern can be much more independent. And you’ll never guess what his suggestion is. The Gowdie Family Wealth portfolio is in fact 100% cash — apart from one single recent investment.
That investment turned out to be a ruse though. It was a test to see if you have the gumption to buy when stock markets do reach the P/E of 10 after a 60% tumble.
Thanks to the political crisis in Eastern Europe, the Russian stock market index is trading near a P/E ratio of five. That’s extraordinarily cheap. Vern’s hypothetical Russian investment, which he sent out to Gowdie Family Wealth readers, was like a trial run. He wanted readers to experience the emotions his subscribers will feel when he does recommend investing in the midst of a crisis.
Apparently the feedback on Vern’s emotional tour was very positive, despite the short lived deception. Now his subscribers are better prepared for when Vern really does pull the ‘buy’ trigger.
For now, Vern’s only actual suggestion is to diversify your currencies a little. The Aussie dollar is looking vulnerable. So he moved some of his own cash into US dollars. The Australian dollar isn’t likely to rally far if it does rally. But if it falls, the fall could be a long drop.
So when Vern does jump into the stock market, what will he decide to do?
Despite his looks, wit and charm, Vern is more of a Beta investor than an Alpha. Beta refers to the wider stock market and its tendency to go up as a whole.
By using Beta and holding a wide variety of stocks, the good and bad fortunes of individual companies become less important than their overall performance as a group. Alpha is your ability to outperform this Beta by stock picking which companies will do well and avoiding those that will do badly.
But alpha can go both ways. If you pick a lemon, you’ve got a real problem. And being active in financial markets is expensive. Buying and selling assets triggers transaction costs that few investors manage to recoup with profits.
Beta, if you pick your bull and bear markets well, can be immensely profitable anyway. It’s much easier to get cycles right than individual company prospects.
Financial markets are only one aspect of Vern’s advice. He also focused on the matter of family wealth in his speech. How do you pass on the wisdom of managing capital, not just the capital itself? After all, wealth can ruin lives about as well as enhance them.
We went to University with two of Vern’s daughters. Luckily our paths never crossed too closely for things to get awkward. But we think Vern should interview them to see how effective he’s been at imparting his wisdom so far. Now that would make for interesting DVD content!
for The Daily Reckoning Australia