Bulls Eye Investor

CHAPTER 2: FAITH VERSUS HISTORY

In the years from the end of 1964 to the end of 1981, the Dow Jones gained exactly one-tenth of 1 percent. In the bull market that followed from 1982 to the peak in March 2000, the Dow rose from 875 to 11,723 a spectacular rise of 1,239% or over 13 times from the starting point.

Gross Domestic Product (GDP) actually grew 373% from 1964 through 1981. During the period from 1982 until the beginning of 2000, the economy grew only 196%, or about half of the earlier period.

Even if you take out the effects of inflation, you find the economy grew almost identically in both periods. In the first period (a total of 17 years) real GDP growth was 74%, and the second (a total of 18 years) GDP was slightly higher at 87%. Yet if you take into account inflation, you didn´t see a profit in your 1966 buy-and-hold portfolio of Dow stocks in 1982; you had to wait another 10 years, until 1992, for an inflation-adjusted return. If you listen to many advisors and analysts today, you should be buying stocks because the U.S. economy is growing, or at least getting ready to grow. This strategy would be valid if the economy was the main driver of stock market prices. The economy more than doubled in real terms from the end of 1930 through 1950. Yet the stocks were roughly the same after 20 years.

A reasonable analysis of the links between stock markets and the economy shows that stock markets do tend to go down before and during recessions, but they do not always go back to new highs after recessions.

The perceived wisdom is that a bear market is when stocks go down by 20% or more. In the recent 18-year bull market, there were several occasions when stock markets dropped by 20% or more (1987 and 1998). Their advisors telling them that new high were around the corner. Each drop in the market was a buying opportunity. Then the music stopped in the first quarter of 2000 it was downhill for almost the next three years. But you would not know that to listen to the pronouncements of the sell-side investment community (by sell-side mean those firms and funds that want you to give them money for their management). Each new low is greeted as the bottom, and the brokers and mutual fund managers find ever more reasons for you to give them your money today.

Staying in the market was precisely the right strategy for the 1980s and 1990s. It was wrong strategy for 1966-1981. It was the right strategy for 2003. It was the wrong strategy for 2000-2002. How do you know what strategy is right for today?

Throughout this book I use the terms “secular bear market” and “secular bull market”, when economists use the term secular, they are generally indicating time periods of longer length.

Since 1,800, traditional analysis suggests there have been seven secular bull markets and seven secular bear markets. The average real return in a secular bear market is 0.3%, and in a bull market is 13.2%.

The average length of bear markets is almost 14 years and for bull markets is almost 15 years. The average complete cycle of a combined secular bull and bear market is 28 years.

If you invested in 10-year period contained within a secular bear market in the past, especially at the beginning, your real returns were quite likely to be close to zero. And that is with the historical advantage of dividends averaging 4 to 5 % or more. In today´s world of dividends that are less than 2%, if this secular bear market should last another 10 years, staying even will be a hard row to hoe.

Within each secular bull or bear market,

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