48: Do You Have Too Little Invested In Stocks?

How fear of another market crash may be causing you to keep your stock market allocation overly conservative despite evidence global stock markets are in a secular bull market.

In this episode, you’ll learn:

1. What are secular bull markets and secular bear markets.
2. How do stocks perform during secular bull markets and secular bear markets.
3. What is the duck test.
4. What are the characteristics of secular bear market bottoms and secular bull market tops.
5. What is the evidence we are in the the early to mid stages of a new secular bull market.
6. What is an earnings yield.
7. Why stock sell offs during secular bull markets tend to be short and shallow.

Show Notes

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Summary Article

Are Stocks In A Secular Bull Market

Earlier this month, I visited my hometown of Cincinnati for my mother’s 75th birthday party.

While there I walked across the John A. Roebling Suspension Bridge, which spans the Ohio River connecting Cincinnati with Kentucky.

When the bridge was opened in 1866 it was the longest suspension bridge in the world.

I crossed the bridge because I wanted to get a better view of the flooding Ohio River. It has been above flood stage for days in this the worst flooding in 20 years.

On the bridge, I marveled at the debris being swept downstream—branches, logs, bottles, buckets and a surprisingly large selection of balls.

When I reached the Kentucky side, I walked among historical mid-19th century homes where the river had swallowed up the streetscape that abutted these brick mansions. Trees, stop signs, and park benches stood submerged in water.

At one home a man sat on a large veranda peacefully reading a book as the ducks and geese swam by his front yard.

He appeared quite confident the river would not reach his front door even though the water was less than 20 feet away. His house was built on higher ground and had most likely not flooded since the great flood of 1937.

But if the river breaches his porch and enters his home (and hopefully it will not) I suspect next time a flood comes he will feel less calm.

Fear of Calamities

Natural disasters such as floods, tornadoes, earthquakes and hurricanes can be traumatizing. For those that have suffered through them, the fear and emotional scars linger. There is the ever-present fear that another disaster is imminent.

Investors experienced their own calamity in 2008 as global stock markets and many other asset categories declined over 30%. The global recession was brutal as unemployment soared, hundreds of banks failed and tens of thousands of families lost their homes to foreclosure.

The emotional trauma of those bleak months lingers six years after global stock markets hit their low. Many investors who suffered great losses during the downturn refuse to return to the stock market, considering it too risky.

Since 2009, global stock markets as measured by the MSCI All Country World Index have returned well over double digits annualized.

Secular Bulls and Bears

Stock markets experience long-term up trends called secular bull markets and long-term down trends called secular bear markets.

From 1940 through 2008, the U.S. experienced two secular bull markets (1941 to 1965) and (1982 to 1999).

The U.S. also experienced two secular bear markets (1966 to 1981) and (2000 to 2008).

The median annual U.S. stock return as measured by the S&P 500 Index during secular bull markets was 19.1%. During secular bear markets the median annual return was 5.1%.

Where have we been since 2009? Is it a continuation of the bear market that began in 2000 or was 2009 the beginning of a new secular bull market?

The Duck Test

There is an inductive reasoning test that Tim Hayes, Chief Global Investment Strategist at Ned Davis Research, applies to global financial markets that can help answer the question.

It is called the duck test. If it looks like a duck, swims like a duck and quacks like a duck then it is probably a duck.

With U.S. stocks returning 17.1% annualized since 2009, equity markets are behaving like they do during secular bull markets. Perhaps it’s time to call a duck a duck, or in this case call it a secular bull market—one that could continue for many years.

Signs of Market Tops and Market Bottoms

Characteristics of secular bear market bottoms include low valuations, excessive fear, high correlation among stocks as they all move in the same downward direction and significant downside trading volume as investors indiscriminately dump stocks because they can no longer stand the pain of losses. That describes the environment in early 2009.

Characteristics of secular bull market tops include bubble like conditions, investor exuberance, narrow leadership and low correlation among different sectors and asset classes as certain sectors and stocks rapidly advance like we saw with technology stocks in 1999.

Currently, global stocks aren’t at either extreme. Markets are not overvalued or undervalued. Fear is still high, but it is waning as investors become more confident the economy will continue to recover, boosting both corporate profits and the stock market.

Cyclical Bears

Of course, if we are in a secular bull (and I think we are) that does not mean we can’t have a market sell-off. Those are called cyclical bears within a secular bull market.

They are healthy for markets because those 10%-to-20% type losses lower valuations and set the stage for a continued secular advance. These cyclical bears tend to be short and shallow as they occur during non-recessionary periods like we saw in 2011 when markets sold off in the mid-teens.

With bond interest rates near historical lows, stock valuations fairly valued and no signs of a global recession, market conditions suggest stocks are better positioned to outperform bonds in coming years.

There are still plenty things to worry about and the fear we felt in 2008 will probably never completely dissipate, but skepticism toward the market’s advance is often what allows it to continue for years without leading to a bubble.

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