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Secular Market Trends

Charles H. Dow, the founder of the Wall Street Journal and keen observer of the stock market, identified three time scales of market action. Primary trends are broad movements that usually last 4-6 years. So long as each successive rally reaches a higher level than the one before and each correction stops at a higher level than the one before, the primary trend is up and we are in a bull market. Conversely, when each intermediate decline carries prices to successively lower levels, and each intervening rally fails to exceed the top of the previous rally, the primary trend is down and we are in a bear market. The major advance in the market that started in spring 1995 is an example of a primary trend or bull market.

Secondary trends are the corrections and rallies during bull markets or the declines and counter rallies during bear markets. Normally, they last from a few weeks to a few months. The rally from October 1998 to April 1999 is an example of a secondary trend. The minor trends are short-term movements that usually last less than a week. A host of technical analysis tools have been developed to deal with stock movements at all three time scales.

This article deals with very long-term, or secular trends. Secular trends typically last 5-20 years and consist of one or more primary trends in sequence. As long as each successive bull market high and each bear market low (expressed in constant dollars) is higher than the previous one, we are in a secular bull market. The converse is a secular bear market. Today (June 1999), we are in the midst of secular bull market that started in August of 1982.

There have been 14 secular trends since 1800: seven secular bull markets and seven secular bear markets. Figure 1 shows a plot of the S&P500 and its precursors on a constant-dollar basis over the past two centuries. The secular bull and bear markets have been marked on the figure.

The impact of secular trends on long-term investment performance is very great. To illustrate this, consider two investors, Mr. A and Mr. B. Mr. A is fully invested during the secular bear market periods whereas Mr. B is invested during the secular bull periods (see Table below). All transactions occur in January, so Mr. A buys a hypothetical index fund in January 1802 and sells it in January 1815. Mr. B buys the fund in January 1815 and sells in January 1835, at which point Mr. A buys again. This continues down until the present. The performance of the two investors is shown in the table below:

Mr. A (Secular Bear Markets) Mr. B (Secular bull Markets)
Period Duration Annual Real Return Period Duration Annual Real Return
1802-1815 13 +2.8% 1815-1835 20 +9.6%
1835-1843 8 -1.1% 1843-1853 10 +12.5%
1853-1861 8 -2.8% 1861-1881 20 +11.5%
1881-1896 15 +3.7% 1896-1906 10 +11.5%
1906-1921 15 -1.9% 1921-1929 8 +24.8%
1929-1949 20 +1.2% 1949-1966 17 +14.1%
1966-1982 16 -1.5% 1982-2000 18 +14.8%
Overall 95 +0.3% Overall 103 +13.2%

Note that despite being invested for nearly a century in lengthy chunks of time running from 8-20 years, Mr. A's overall return is less than 1% per year in real terms. Mr. B gains an average real return of 13% for his 103 years in the market.

Half of the time, such as the last 18 years from 1982 to 2000 investor's are in Mr. B's happy situation; most large-cap stock investments are profitable over a multiyear holding period. With an average return of more than thrice the real interest rate, an index fund is always a better investment during a secular bull market than are bonds. The rational strategy during the secular bull market is then to buy those stocks that are strongly participating in the bull market, regardless of their valuation. The stronger the participation (i.e. the higher the relative strength) the more the stock is worth. The enormous valuations on tech stocks (and especially internet stocks) in recent years can be seen as a direct evidence of the impact a secular bull market has on investor behavior. We should expect that relative strength or momentum methods will remain superior to other investing methods until the end of the secular bull market.

The other half of the time, most recently the 1966-1982 period, investors are in Mr. A's frustrating situation. An index fund under these situations gives a poor return and may actually lose ground to inflation over long periods of time. This was the case in 1966-1982. Since the market has little, if any uptrend during these periods, one might expect that momentum-based strategies will fare particularly poorly during these periods.

The current secular bull market has lasted 18 years through 2000. The average length of a secular bull market is about 14 years, so this secular bull has already lasted longer than average. Two previous secular bull markets have lasted 20 years, however, so 18 years is not unusually long. We would like to develop an estimate of when this secular bull market might end. Figure 2 shows a plot of the market value (P/R) over time. Unlike the index itself, which rises, P/R oscillates from a low value of about 0.25 to a high value of about 1.5. Periods of a rising P/R trend are secular bull markets; periods with a falling P/R trend are secular bear markets.

P/R is the ratio of the price to business resources (R). R is calculated by adding the retained earnings (in constant dollars) for each year on a representative index (like the S&P500 index and its precursors) to R for the previous year. R is assumed equal to real index value for the initial year. For example, R in fall 1999 for the S&P500 was $950. Of this value, $880 represents accumulated retained earnings (all expressed in 1999 dollars) from 1871 to 1999. The other $70 represents the initial value of the index (in today's money) in 1871.

The index price is also converted to constant dollars. The quotient of the index value and R gives P/R. As of the end of 1999, the S&P500 had reached a monthly average of about 1420, and P/R had reached a value of 1.47. Examination of Figure 2 shows that previous secular bull markets, with one exception, ended at P/R in the range of 1.2-1.35. The exception was in 1966, when the post war secular bull market ended unusually early at only a P/R of 1.08. The average P/R at the end of the six previous secular bull markets is 1.25± 0.09 at 1.47 P/R is 2.4 standard deviations above the level it had reached at the ends of previous secular bull markets. Surely the end of the secular bull market must be at hand.

Figure 1. The performance of the stock market
(in constant dollars) over the past 200 years
Dividend-Adjusted Market Index
Figure 2. Market value (P/R) over time
Price to Resources

Author's Note: This was the situation at the beginning of 2000. Since then we all know that the stock market peaked in March 2000 and has begun a serious bear market correction since then. The Stock Cycle analysis suggests that this was the end of the secular bull market that began in 1982. After the discovery and characterization of the stock cycle in 1997, it remained a curiosity, a simple technical tool of unproven worth. In October 1999, I happened upon the Longwaves site and learned about the Kondratiev Cycle or K-cycle. In short order I learned that the stock cycle was directly dependent on the Kondratiev Cycle. Figure 2 shows the Kondratiev peaks and troughs defined by the secular market trends. Those familiar with the K-cycle will recognize these as points similar to those determined by wholesale prices and other economic indicators. Having found an explanation for secular trends, I wrote a book called Stock Cycles: Why stocks won't outperform money markets over the next twenty years.

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