Time for the Defense to Take the Field

Barron’s – 11/12/09

THE BULL MARKET IS NINE MONTHS OLD, a financial news Web site trumpeted, as if a birth announcement should be expected momentarily. But, say a couple of seasoned seers, this has been only a baby cyclical bull in a secular bear market that is far from running its course. Psychology currently is reaching bullish extremes while valuations never came close to the nadirs that have been associated with past bear-market bottoms.

Albert Edwards, Societe Generale’s world-class global strategist, points to the scarcity of bears among the newsletter writers tracked by Investors Intelligence, which last week fell to the lowest level since the stock market peaked in 2007.

« The likelihood is that the next leg of the long-term structural bear market is closer than people realize, » he writes in a note to clients. While Edwards has steadfastly pointed to Japan and its stock and bond markets as the examples the West should study for long-term patterns, he similarly argues that investors could have participated in cyclical rallies of 40%-50% in Tokyo — even though the Nikkei stands some 75% below its 1989 peak. The key, he explains, has been to exit the Tokyo stock market when leading indicators for the Japanese economy show signs of topping out. That’s usually just about the time analysts start to argue that the economy, at long last, is about to embark on a sustained expansion. Which has yet to happen.

Similarly, Martin Pring, the veteran market technician who heads up the Pring Turner Capital Group investment advisory, sees the U.S. stock market still mired in a « Lost Decade » of nil net equity returns. Indeed, based on the history of past secular bear markets, we’re only halfway through the current episode, he contends. And like Edwards, Pring says the key is to trade among asset classes — and not hew to the buy-and-hold and static indexation strategies that work in secular bull markets.

Both market mavens see economic swings becoming more volatile — as opposed to the Great Moderation of the past decade when the Federal Reserve and other central banks could simply throw money at the markets any time they faltered, thus limiting downturns. Of course, that inflated successive bubbles, for which we’re now paying the price. « Ben Bernanke tells us we should learn the lessons of Japan and so we must, » Edwards acerbically asserts. Which means getting in on cyclical rallies — and then getting out. « Though many commentators want to complicate the investment business, we try to keep our advice as simple as possible. The leading indicators have begun to turn down in the U.S…and so risk assets are therefore dangerous. »

Among the gauges that are rolling noted by Edwards are the weekly leading indicator from the Economic Cycle Research Institute and the Index of Leading Indicators compiled by the Conference Board. « Almost no one will be willing to predict renewed global recession and no one will predict new lows in equities, » he continues. « And with the market so bullish…a cyclical failure will come as a crushing blow to sentiment. »

« It is time to sell, » Edwards flatly declares.

As for the market itself, he points to the 50% retracement level on the Standard & Poor’s 500 at 1120, which is being watched intently by every trader, individual investor and professional money manager that spares even a passing glance at the charts. The failure to break through that key level points to a near-term top, according to technical analysis. From a fundamental standpoint, the market continues to confront far greater difficulties than in the past, Pring observes. « To give you an idea of the kind of challenges faced by investors in a secular bear market, it is worth noting that the last secular bull market (1982-2000) covered 18 years but contained only two recessions last a total of 12 months — that is, less than 6% of the time. « Compare that to the last 10 years, in which the secular bear market experienced two recessions last a total of 28 months, or about 275 of the time. That is far closer to the U.S. experience of the past 150 years, where the economy spent an average 31% of the time in recession, » he adds. That means investors need to be nimble, given the greater economic volatility, Pring continues. « Essentially, an investor needs two game plans; one for defense, to protect assets in difficult periods, and one for offense, to grow wealth during favorable conditions. »

After running up the score with 50%-plus gains from lows of last March, it looks like a good time for the defensive team to take the field.

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