Significance of secular market should not be underestimated
Washington Post, November 9, 2014
People who work in specialized fields seem to have their own language. Practitioners develop a shorthand to communicate among themselves. The jargon can almost sound like a foreign language.
Finance is filled with colorful phrases such as “Spoos,” “Vol,” “Monte Carlo simulation,” and “Gaussian Copula.” In these columns, I try to eschew the usual Wall Street jargon. But I have used the phrase “secular cycles” (most recently here), and a reader recently called me on it. To redress that error, this week I will discuss what a secular — vs. cyclical — market is, its significance and what it might mean to your portfolios.
Based on a lifetime of observations and a few decades in the markets, I have come to understand that societies, beliefs and fashions all move in long arcs of time. We call these arcs several things: cycles, periods, eras. They vary in length and intensity, but they are typically characterized by an idiosyncratic set of qualities that set them apart from each other as unique.
Regardless of the name we affix to them, we intuitively understand what defines a specific period of time. If you name an era, I can describe for you the dominant economic and societal themes and trends. Ultimately, all of these eventually find their way to equities and bonds.
Rather than describe these obliquely, let me give you a definition, and then a few specific examples:
Secular cycles are the long periods — as long as decades — that come to define each market era. These cycles alternate between long-term bull and bear markets. Societal elements affect these markets. These cycles are driven by specific and dominant economic ideas.
Each secular market cycle reflects the key issues of an era. These can include geo-politics, economics, resource consumption, technology or any one of a number of other elements. Over time, each of these factors comes to define the dominant economic theme of a generation. Consider the post-War World II era, or the inflationary malaise of the 1970s or even the roaring 1980s and 1990s. Each period can be defined as a secular cycle.
With each secular cycle, a dominant Market Trend emerges. Historically, these have been extremely powerful and, once established, are very difficult to break. They can last 10 to 20 years.
As an example, let’s use the post-World War II boom. This long expansion lasted from 1946 to 1966 (with a few mild recessions along the way). The economy was driven by a broad assortment of factors that all aligned at once: Millions of troops returned home from the war; more than half of them took advantage of the GI Bill, which provided a stipend ($110 per month) to obtain a college education. A well-educated workforce never hurts the economy.
After being on a wartime footing for so long, civilian manufacturing responded to years of pent-up consumer demand. Commercial aviation expanded until it became an ordinary part of life. The electronics industry expanded rapidly and the seeds for the semiconductor and software revolution were planted.
The postwar period also saw the suburbanization of America, the rise of the homeowner, the build-out of the interstate highway system and the rise of automobile culture. Credit availability expanded dramatically.
Given these factors, would it come as a surprise to learn the stock market had a good run from 1946 to 1966? The long boom led to a long market rally. During that period, the secular bull produced outstanding returns. The Dow Jones industrial average was well under 200 in 1946. By 1963, the Dow was trading five times higher at a level of 1,000.
This postwar expansion was followed by another secular cycle — the ugly secular bear market of 1966-1982.
For example, say to a person “the 1970s” and they will conjure a vivid memory of that era: disco, polyester, gas lines, stagflation, as well as recession. It was an era of socio-political upheaval and a general economic malaise, defined by spikes in inflation, the Watergate scandal, the oil embargo and the Vietnam War. The market experienced a lot of rallies and sell-offs, but stocks failed to make much forward progress overall. The Dow kissed 1,000 in 1966 but did not manage to get over it on a permanent basis until 1982 — 16 frustrating years later.
The period from 2000 to 2013 was similar. Defined by the bursting of the dot-com bubble, 9/11, massive corporate accounting frauds and the wars in Iraq and Afghanistan, it too featured an inflationary spike and high oil prices. But the financial crisis killed inflation, making deflation the greater threat. Big rallies and sell-offs also defined this era. The S&P 500 hit 1500 in 2000, but did not climb above that until some 13 years later in 2013.
The 1982-2000 era is worthy of its own book. I suggest “Bull: A History of the Boom and Bust,” by Maggie Mahar. The patterns seem to keep repeating.
That is the yin and yang of long cycles. The underlying factors that drive each era come to dominate them. Sometimes it’s war, or inflation, or technology, or some combination of these. But they are extremely powerful, and they can drive global economies for decades at a time.
The takeaway is that we continue to see secular bull markets leading to secular bear markets which, in turn, lead to new secular bull markets, and the cycle repeats into the future.
My own views have been slowly inching into the new secular bull market camp. While we can never be certain about these things until they are long past, the great secular bear market of 2000-13 appears to have finally ended. But as I noted, we can never be sure of these things until afterward. The 1966-1982 era looked like it was over in 1980, only to see a 28 percent slide to the 1982 lows.
Several factors have influenced my thinking that we are entering a new secular cycle.
Stock prices: By spring 2013, most major U.S. stock markets and indices had broken above their previous range. All-time highs soon followed, including for the Dow Jones, the Russell 2000 and the S&P 500. The Nasdaq is the only laggard. Having fallen 78 percent from its March 2000 peak, it has yet to recover to its prior highs, which are still almost 20 percent away.
Economic expansion: Over the past five years, I have often referred to academic studies showing that typical post-credit crisis recoveries are much weaker than the usual recession recovery. I have warned of subpar GDP, weak job growth and poor retail sales. And, in fact, that is what we have gotten — and still the market has powered higher. As the economy continues to slowly heal, it should reflect in improving earnings, which is always a positive for equities.
Disbelief in the rally: When I speak with folks who worked on The Street in the 1970s and 1980s — people like Jeff Saut, chief strategist at Raymond James, or Ralph Acampora, the former director of technical analysis for Prudential Securities and founder of the Market Technicians Association — they all make comments about how similar the current sentiment is when compared with the environment in the early 1980s. No one back then seemed to be willing to accept that the 1970s bear market was over. The same skepticism is present today.
The wild card, of course, is the Federal Reserve. We are in a historically unprecedented era. Quantitative easing (QE) and zero interest rate policy (ZIRP) have been conducted on a scale that never happened before. Now they appear to be ending. No one knows what that unwind will look like, or what possible ramifications it might bring.
Aside from that unknown, most of the other factors are lining up to suggest that we are entering a new secular bull market.
Two last things worth mentioning: We have had a terrific five-year run, without much of any sort of correction or pullback. No one knows when the next 15 to 20 percent correction will occur, but it should not surprise us if we see something along those lines. As a reminder, five years after the last secular bull market began in 1982 we had that little glitch in 1987. While history does not repeat that precisely, a one-day 23 percent fall is certainly worth remembering. Most people forget that markets actually finished 1987 up, albeit a mere 1 percent.
Finally, if historical patterns hold true, and this is a new secular bull market, it could last much longer — another decade or more. We won’t know for sure until it is in the history books.
Ritholtz is chairman and chief investment officer of Ritholtz Wealth Management. He is the author of “Bailout Nation” and runs a finance blog, the Big Picture. On Twitter: @Ritholtz.