For all the index investors - We're in a sideways market for at least 6 years

http://www.marketoracle.co.uk/Article28881.html

Best to understand history and emperical evidence. Secular bear markets grind sideays for a good 16 years to 21.

Index investing is going nowhere for the next 6 years at least IMO for the western stockmarkets.

A pity really because index investing is excellent during long term secular bull markets (i.e 1982-2000) to keep management fees low. Index investing during secular bears is not a good strategy IMO.

Best to stick to value defensives that have already hit P/E and div yield secular lows for a few years yet.

Discuss...

New Stocks Bear Market?

Stock-Markets / Stock Markets 2011 Jun 24, 2011 - 12:28 PM

By: Zeal_LLC

Thanks to June’s sizable and rather-sharp stock-market selloff, fears are growing that a new bear market is brewing. For investors and speculators, the implications of these concerns are not trivial. Optimal trading strategies vary wildly between bull and bear, as bears relentlessly maul down all sectors including popular ones like commodities stocks. So today’s bull-or-bear question is critically important to address.

A bear market is simply a prolonged period of falling prices. These dreaded beasts come in two distinct breeds, secular and cyclical. Secular means long periods of time, on the order of a decade or more in financial-market terms. The US stock markets have actually been continuously mired in a secular bear for over a decade now. So any new stock bear can’t be secular, as we’re still languishing in an old one.

At the other end of this duration spectrum are the shorter-term cyclical moves. In the financial markets, cyclical generally implies a couple/few years or so. Cyclical bulls and bears occur within their secular cousins. Secular bulls and bears, driven by Long Valuation Waves, tend to persist for 17 years each. Inside these great 17-year trends, several-year cyclical bulls and bears perpetually alternate.

Any new stock bear today has to be cyclical. The US stock markets (as measured by the flagship S&P 500 stock index (SPX)) soared 102% higher between March 2009 and April 2011 in a powerful cyclical bull. So a cyclical bear is certainly due next when the past-couple-years’ bull inevitably gives up its ghost at some point. Is that time now? Maybe, but we don’t have a high-probability new-bear setup yet.

All this secular-cyclical bull-bear stuff is much easier to understand once you see it visually. This first chart superimposes today’s SPX secular bear since 2000 over the last secular bear that ran from 1966 to 1982. Note that contrary to popular assumptions on bears, their secular variants don’t see prices fall straight down. Instead a secular bear is a long consolidation, a demoralizing 17-year sideways grind.

These giant secular-bear trading ranges are readily evident in this chart. Ever since the last secular bull ended in early 2000, the SPX has traded in a massive sideways range running from roughly 750 on the low side to 1500 on the high side. Today’s secular bear started near 1500 in March 2000, and this level isn’t likely to be significantly exceeded until this secular bear fully runs its course by 2016 or so.

But within the bounds of this secular trading range, powerful cyclical bears and cyclical bulls meander. The cyclical bears tend to cut the headline S&P 500 in half, while the subsequent cyclical bulls tend to double it. These big swings are very tradable, but their net result is a wash. Even at the peaks of these mighty cyclical bulls, the SPX doesn’t achieve levels much better from where its secular bear was originally born.

The latest cyclical bull running from March 2009 to April 2011 definitely achieved this doubling, rallying 101.6%. This is nearly identical to the previous cyclical bull’s 101.5% gain between October 2002 and October 2007. So with this latest doubling right in line with classical mid-secular-bear cyclical-bull expectations, isn’t a new cyclical bear likely? Unfortunately the answer is not as clear-cut as usual.

Back in autumn 2008, the US stock markets plummeted in the first true stock panic in 101 years. These ultra-rare events are driven by a mind-blowing explosion of popular fear. That fear, as measured by the definitive VXO fear gauge, climaxed in November 2008 when the SPX closed at 752. This was right at the lower support of this secular bear’s trading range, where today’s cyclical bull ought to have been born.

But unfortunately in early 2009, the United States of America suffered a change in management thanks to the stock panic’s horrendous impact on sentiment during the November 2008 elections. In early 2009 the incoming Democrats terrified the stock markets with their brazen claims that the already-crushing taxes on American investors and businessmen were too low. They also threatened endless new job-destroying regulations, primarily socialized medicine, that would choke off the fragile post-panic recovery.

This Democrat Despair peaked in early March 2009, driving a much-lower secondary panic low of 677 on the SPX. Not only are such secondary lows unheard of in the history of panics, but the fear reads of these two bottoms confirm this was a curious anomaly. When the SPX hit its original and true panic bottom of 752 in November 2008, the VXO fear gauge closed at an epic 87.2! But in March 2009 when the SPX slumped to 677 in despair, the VXO merely closed at 51.5. This was 41% less fear!

Fear, and hence the proper stock panic, climaxed in November despite the lower secondary March low! Even though this secondary low was not righteous, a total anomaly, the subsequent cyclical stock bull is still measured from it. March’s 677 was 10.1% lower than November’s 752. If we instead consider this bull as launching from its true panic low, it was only up 81.2% by its latest interim high in late April 2011.

Traders can get in trouble by failing to relegate anomalies to their proper context. Technical analysis is often more accurate for gaming future price action if extra-trend anomalies are simply disregarded. While this thread is too peripheral to hang the whole new-cyclical-bear question on, it is provocative. Yes the latest SPX cyclical bull achieved its expected doubling, but that was from a short-lived anomalous base.

Way more important is where the SPX is today within its giant secular trading range. Remember that since 2000, this flagship index’s secular resistance has run around 1500. In March 2000, the SPX hit 1527 on close before the first cyclical bear of this secular bear emerged from hibernation. In October 2007 before the second cyclical bear was born, the SPX briefly hit 1565 on close. Cyclical bulls fail near 1500.

Yet in April 2011 when our latest cyclical bull hit its best levels, the SPX was only at 1364. This was still 9.1% under its secular resistance, which is pretty low to kill a major cyclical bull. Stated the other way, even from its latest April peak the SPX would have had to rally another 10.0% to hit its 1500 resistance. And such a resistance approach would almost certainly signal the beginning of a new cyclical bear.

It’s certainly true that not every cyclical bear has to drag the SPX down to support, nor does every cyclical bull have to carry it up to resistance. The red 1970s-secular-bear line above really drives home this point. Secular trading ranges, like all trading ranges, are probability bands. The closer to support a price travels, the greater the odds a major rally is imminent. The closer to resistance, the more likely a major correction is nearing.

Having the SPX relatively high in its secular trading range in late April makes a new bear market far more likely than it was earlier in this bull. There were new-bear fears in both the summers of 2009 and 2010, which I argued were irrational at the times partially based on this analysis. And while the odds of a new bear are much higher now than in the last couple summers, the SPX still has lots of room to run yet to hit its secular resistance that would herald a high-probability cyclical bear.

So the cyclical bull-bear cycles are not overwhelmingly predicting a new cyclical bear today. While today’s cyclical bull indeed hit its target doubling, that was from an anomalous secondary low well under secular support. And this latest cyclical bull hasn’t yet pushed the SPX anywhere near its secular trading range’s resistance around 1500. So a new cyclical bear today certainly isn’t a high-odds bet yet.

This second chart zooms in to just the secular-bear trading ranges and looks at another aspect of mid-secular-bear cyclical bulls. Their durations. Our current cyclical bull is only 26 months old, which is maturing but still on the young side for mid-secular-bear cyclical bulls. This also means that we aren’t yet to the point where there’s a high probability a new stock bear is being born.

In the entire modern history of secular bears, there have been five cyclical bulls before today’s. This includes an earlier one in today’s secular bear, and four back in the 1970s secular bear. Their average duration was just under 35 months. Today’s sixth cyclical bull is only 26 months old since March 2009, or 29 months old if you want to measure from the true panic low in November 2008.

While it is maturing, it remains far from even hitting an average duration yet. This too really reduces the likelihood that a new cyclical bear is being born today, especially after a once-in-a-century stock panic. Following the last cyclical bear’s epic fear at its climax during the panic, a bigger and longer cyclical bull than normal is highly likely. Market extremes, both in technical and sentimental terms, are gradually erased by outsized swings to the opposite extreme.

So it is hard to imagine today’s cyclical bull ending before it has even reached an average lifespan around 35 months. Odds are it will persist longer, at least if it isn’t to the top of its secular trading range yet. There is a good chance the SPX will start rallying again after the current correction, in autumn at the latest. It will probably power higher through spring 2012, before the ridiculously-negative election rhetoric hammers sentiment once again.

As cyclical bulls mature, their ascent rates tend to moderate. Bulls’ best gains happen right out of the deeply-oversold fear-laden lows left by climaxing cyclical bears. Their first years are their best, as capital floods back into stocks. But the more capital that returns, the less is left on the sidelines so the buying pressure slows in relative terms. So if our current cyclical bull indeed yields a third year, we can’t expect anything more than modest gains (from April’s high) into next spring.

This discussion may seem ambiguous, but calling transitions from cyclical bulls to cyclical bears is always fraught with uncertainty. Unlike fear-laden cyclical-bear climaxes which are sharp and crystal-clear, cyclical-bull toppings are usually slow and plodding. The greed that drives cyclical-bull peaks is a much-less-urgent emotion than fear, way slower to build and grow excessive. Was the SPX’s latest interim high greedy and complacent enough to kill this latest bull? Only time will tell.

Cyclical-bull-to-bear transitions are only readily apparent in hindsight. As mere mortals we can’t know the market future before it happens, all we can do is game probabilities. And while the odds of a new cyclical bear are certainly growing, they remain far from approaching the very-high levels necessary to actively bet on a new-stock-bear thesis. We won’t know for sure a new cyclical bear is upon us until the SPX falls 20%, which officially marks bear territory.

A 20% decline in the SPX from its late-April high would take it to 1091. That is still a long ways down from here! But cyclical bulls can see big corrections that approach cyclical-bear magnitude but never quite hit that 20% metric. I labeled some big mid-bull corrections in this chart that occurred in the latter halves of the last couple secular bears. They averaged 15.2% declines in a little over 8 weeks.

The best modern example occurred last summer, when the SPX fell 16.0% over 10 weeks culminating in early July. That was a big selloff, but it certainly didn’t mark the birth of a new cyclical bear. Corrections are healthy and necessary within ongoing bull markets. They rebalance sentiment by quickly injecting fear to offset greed and complacency before they get too excessive. Without corrections, bulls would burn themselves out prematurely.

Back in mid-April soon before today’s selloff started, for a variety of reasons I predicted an imminent correction in the SPX. Complacency and greed were again approaching unsustainable extremes and needed to be rebalanced away. Corrections are mid-bull selloffs running between 10% and 20%, with pullbacks being under 10% and bear markets over 20%. As expected, that correction is indeed now coming to pass and won’t end until fear gets high enough.

The ironic thing about healthy mid-bull corrections is traders always mistake them for new bear markets! You may recall this happened last summer during this cyclical bull’s only correction. The popular new-bear belief was so prevalent by mid-July 2010 that I wrote a whole essay debunking it. This contrary opinion was very unpopular at the time, as traders extrapolated that selloff continuing indefinitely.

But those who believed last summer’s false bear theories missed a super-profitable cyclical-bull year since. The lower today’s selloff drives the SPX, the more prominent new-stock-bear theories will become yet again this summer. Before the SPX decisively bottoms, odds are popular consensus will be talking about nothing but bad news and the budding “new bear market”. But such fears and anxiety are totally normal in healthy bull-market corrections, and necessary to rebalance sentiment.

It is critical for investors and speculators alike to realize that price action drives news, not the other way around as most assume. After the stock markets have been rallying for a long time in a strong upleg, there is nothing but great news and rosy optimism just as the markets are topping. And after a major correction, all you see is bad news and pessimistic rationalizations about why we are plunging into a new bear. Newsflow is super-bullish at major interim highs, and super-bearish at major interim lows!

So bear talk is actually a contrarian indicator. The more traders are talking about a new stock bear, the greater is popular fear. And the more extreme fear gets, the higher the odds that a major bottom has arrived. Just last week I heard the first new-bear comments I’ve seen on CNBC since last summer, and I expect this thread to grow way more popular before this correction runs its course. But bear talk doesn’t make a bear.

Today’s cyclical bull, while maturing, remained far from its secular resistance at its latest interim high in late April. While it did experience a doubling, that was from an anomalous post-panic low that wasn’t righteous. And this bull remains well below the average mid-secular-bear cyclical-bull duration. And if there was ever a time to see a longer-than-average cyclical bull, it is after a once-in-a-century stock panic. So despite the increasing bearish talk, we don’t have a high-probability setup for a new cyclical bear yet.

At Zeal we’ve been studying bull-bear cycles for well over a decade. There are no strategic developments more important to traders than transitions between bulls and bears, so it is critical we gain the knowledge and wisdom necessary to greatly increase our odds of recognizing them in real-time. Our bull-bear research has been a major factor contributing to our stellar trading track record. Since 2001, all 583 stock trades recommended in our newsletters have averaged annualized realized gains of +52%!

We naturally share the very-profitable fruits of our hard work with our subscribers, who finance our ongoing research. Our acclaimed weekly and monthly subscription newsletters weave together our vast research, knowledge, and wisdom to help speculators and investors better understand what the markets are doing, why, and where they are likely heading. When the odds are favorable, we recommend specific trades you can mirror with your own capital. Subscribe today and start thriving!

The bottom line is the odds are not high today that a new stock bear is upon us. The past couple years’ cyclical bull remains well below the average duration of mid-secular-bear cyclical bulls. And the SPX’s latest interim highs were also well below their secular-bear resistance. Following a once-in-a-century stock panic’s epic fear, the subsequent cyclical bull should be bigger and longer than normal.

So we’re probably due for another year or so out of this cyclical bull before the next bear awakens, albeit with moderating gains. Nevertheless, as always during healthy mid-bull corrections the new-bear talk will grow in popularity. This is a natural consequence of the increasing fear and anxiety that corrections spark, and a great contrarian indicator. Corrections bottom just when everyone expects a new bear.

Adam Hamilton, CPA

So how can you profit from this information? We publish an acclaimed monthly newsletter, Zeal Intelligence , that details exactly what we are doing in terms of actual stock and options trading based on all the lessons we have learned in our market research. Please consider joining us each month for tactical trading details and more in our premium Zeal Intelligence service at … www.zealllc.com/subscribe.htm

Questions for Adam? I would be more than happy to address them through my private consulting business. Please visit www.zealllc.com/adam.htm for more information.

Thoughts, comments, or flames? Fire away at zelotes@zealllc.com . Due to my staggering and perpetually increasing e-mail load, I regret that I am not able to respond to comments personally. I will read all messages though and really appreciate your feedback!

Copyright 2000 - 2011 Zeal Research ( www.ZealLLC.com )

Click to expand...

WARNING This is a Market timing subscription newsletter and you should ignore it as there is no evidence in a multitude of academic research papers that attempting to follow a market timing strategy adds value to a portfolio.

As the USA celebrates it's 235th birthday, Wall Street was in a generous mood by giving nearly a trillion dollars in gains this week. To be more precise, the US stock market rose every day this week, increasing by a total of 5.6 percent, as measured by the broadest US stock index, the Wilshire 5000. This 5.6 percent gain translates to about $910 billion dollars. Damn these "Secular Bear Markets" are expensive for investors!

Stocks are always risky. It’s not like when you go to the beach—if there’s a green flag it’s safe, and if there’s a red flag you stay out of the water. There’s never a green flag for stocks. People may think it’s safe like they thought it was safe in the late ’90s. But stocks are always risky. It has to be so. Otherwise there would be no risk premium.

The problem is there’s a difference between risk and uncertainty that many people don’t understand. Most investors focus on the wrong thing. They’re trying to manage returns somehow—either by themselves or by hiring active managers to do it. They’re all playing what Charles Ellis called a loser’s game. You can’t control what you can’t forecast.

As legendary Fidelity fund manager Peter lynch said more money has been lost worrying about the next bear market than is actually lost in the bear market.

Remember the market has a habit of handing out large tuition bills to those who ignore the fact that current prices are an unbiased predictor that is to say they are the best estimate of fair value at anytime.

[broken link removed]

For an explanation of this graph see [broken link removed]

Investors who bet against the market are arrogant enough to believe that they know more than the combined views of all other market participants. In other words EVERYONE else is wrong and I am right.

Of course this may turn out to be the case simply by luck. If i keep saying the market is going to go down ill be right eventually. What does the evidence say? In large studies or market timing newsletters, few manage to achieve even a 50 50 success rate that i would expect from my two year old randomly selecting buy or sell recommendations.

Perhaps Warren Buffett was right when he said: ‘‘We have long felt that the only value of stock forecasters is to make fortunetellers look good. Even now, I continue to believe that short-term market forecasts are poison and should be kept locked up in a safe place, away from children and also from grown-ups who behave in the market like children"

Ill happily offer a subscription service to my sons guesses on the future direction of the market but are you willing to bet your retirement on it?

An Analysis of Secular Bear Markets and Secular Bull Markets since 1900

From a historical perspective since 1900 there have been 3 Secular Bull Markets and 3 Secular Bear Markets as shown by the tables below of the Dow and S&P 500. As you can see during a Secular Bull Market the Average Annual Return (highlighted in red) is considerably higher than during a Secular Bear Market (highlighted in blue). Thus the long term Buy and Hold strategy that worked well in the 1980's and 1990's for investors may have not worked very well during the Secular Bear Markets of 1906-1921, 1929-1949 and 1966-1982.​

Secular Bear Markets vs Secular Bull Markets and Dow Performance

Secular Bear Duration Avg Yearly Ret Secular Bull DurationAvg Yearly RetMarkets(Years)(Dow)Markets(Years)(Dow)

1906-1921 16 1.58%
1922-1928 7 17.20%
1929-1949 21 1.69%
1950-1965 16 10.60%
1966-1982 17 1.59%
1983-1999 17 15.30%
2000-?


Secular Bear Markets vs Secular Bull Markets and S&P 500 PerformanceSecular BearDurationAvg Yearly RetSecular BullDurationAvg Yearly RetMarkets(Years)(S&P 500)Markets(Years)(S&P 500)

1906-1921 NA NA
1922-1928 7 17.90%
1929-1949 21 2.34%
1950-1965 16 11.40%
1966-1982 17 3.64%
1983-1999 17 14.96%
2000-?

The big question is now are we in the beginning stages of a 4th Secular Bear Market which started in 2000. The average length of the previous 3 Secular Bear Markets was 18 years with a minimum of 16 years and a maximum of 21 years. Thus if you add 18 years to the year 2000 and take + or - 3 years on either side then the next Secular Bull Market may not begin until sometime in the 2015 to 2021 time period if we are now entering a 4th Secular Bear Market. However I would like to point out that even in a Secular Bear Market there can still be Bull Markets lasting a year or two as the longer term charts of the Dow show below.​

Click to expand...

Based on history, index purchasers now will be lucky to break even after inflation over the next 4 to 10 years.

I guess 'its different this time'?

A different strategy from index investing is required until the next secular bull market begins. We are 4 years away as a bare minimum.

I am happy to index invest during a secular bull at a nice 0.15%-0.25% in fees but now is still not the time to do so.

With the Western markets peaking on their highest ever P/Es in 99/00 then we have a serious regression below the mean before indexes become cheap enough to boom again. This implies a long drawn out secular bear.

Even at the market low of 2009, some 9 years since the secular bear market started, the CAPE P/E ratio bottomed at a level that was way too high and way too early to mark a secular low in order to allow a secular bull to form.

http://www.ritholtz.com/blog/2010/02/what-is-the-cyclically-adjusted-pe-ratio/

My tea leaves were also giving a strong sell signal and I saw a single Magpie today.

Better get all our clients out of the market quickly

All these so called valuation signals have been tested empirically and none have been shown to be reliable predictors of future market returns.

Marc said:

All these so called valuation signals have been tested empirically and none have been shown to be reliable predictors of future market returns.

Click to expand...

What I find interesting is that you would buy the market, however expensive.

The Nikkei in 1989 at 50-100 times earnings and dow in 2000 at 35 times earnings, would be fine for the index investor?

Personally I rather look at history at it often goes in long cycles to give the decades in which index investing is probably worthwhile and the decades in which it probably isn't. No exact science but currently proving exactly as history shows.

We are currently in the latter in which index investing is not a good move.

I rate equities a lot at present (value defensives), I just don't rate the Western indexes (Except Japan, the rest are half full of highly cyclical and expensive trash).

Regarding the graph you posted - a 100% rise followed by a 50% fall equates to a zero move. Therefore the upward percentages should be half the height than the downward falls to put it into better perspective. Likewise it represents 'cyclical' moves up and down, these are not the same thing as 'secular' long term trends.

Cumulate all the minus figures in the secular bear of 1966-1982 or the secular bear of 2000-2011 against the positive figures and what you get is a sideways market. add in inflation over these periods and what you get is negative returns or break even at best for index investors during these secular bears. its a sad fact of life and one that every investor needs to be aware of.

Marc said:

My tea leaves were also giving a strong sell signal and I saw a single Magpie today.

Better get all our clients out of the market quickly

All these so called valuation signals have been tested empirically and none have been shown to be reliable predictors of future market returns.

Click to expand...

Valuation methods may not work in market timing sense, but surely when Hussman's peak to peak earnings method, John Bogle's expected returns method, GMO asset class expected return, Gordon Eqn all point to low expected long term returns on the S+P that it v likely that will be the case. I don't believe such models should be used as market timers but to give the investor a realistic expectation of future longterm returns. Such evaluation models are most valuable IMO when stocks, as must surely happen, fall out of favour as an asset class and become very cheap to help assure the investor to invest in a climate of pessimism and high expected returns.

I got a puncture on my cycle this morning. Boy, did I not see that coming. On the plus side it's gonna be six years before I get another one.

elcato said:

I got a puncture on my cycle this morning. Boy, did I not see that coming. On the plus side it's gonna be six years before I get another one.

Click to expand...

It's all to do with valuation.

The market goes in long term (secular bull) uptrends that peak on high P/E multiples followed by which the market then goes on a long term sideways trend (secular bear).

The secular bear usualy last 15-25 years or so until the valuation of the market as a whole becomes exceptionally cheap.

This is merely what history shows us time and time again.

[broken link removed]

Valuation is everything when it comes to expected returns. Everything.

Buying the index now is a better thing to do than buying thr index in 2000 (when P/Es were the highest ever) but based on history, buying the indexes in 5-10 years or so will likely be a better thing to do than pile into indexes now.

After the biggest bull run in history with P/Es peking in 2000 on their highest level ever, then it would imply that we are in for a correspondingly long secular bear market until P/Es hit rock bottom. This process usually takes a couple of decades.

As albert said, no one can predict the market on a short term basis, however valuations and the regression cycle of valuations over time (from overvalued to undervalued to overvalued again) is everything when it comes to expected future returns.

Buyng Western indexes in the middle of a secular bear is likely to result in sub par performance against inflation over the course of a number of years.

Marc said:

All these so called valuation signals have been tested empirically and none have been shown to be reliable predictors of future market returns.

Click to expand...

Wish more people would realise this is fact not persons out there trying to act GOD in relation to their market knowledge. In fact working on historical facts really means that know damn all.

I'd be more interested in who is buying what right now.

ONQ.

ringledman said:

It's all to do with valuation.

Click to expand...

Actually it's not!!! Valuation does play a part in the equation, but there are others and asset allocation is one of the primary ones.

You make the assumption in your analysis that what you call "Index Investors" simply blindly just buy an index and carry on. Based on my experience, I would say that a majority of what you call "Index Investors" are in fact practising an asset allocation strategy using index ETFs as an easy way to execute the strategy. That being the case, they would not as you suggest be pumping money into over valued indexes, but would in fact be at that point putting money into other asset classes.

Furthermore, more actively managed portfolios tend to make use of sector index ETFs so that they can make tactical allocations over and under weighting sectors based on valuation and expected performance. They don't simply buy the S&P 500 or the MSCI Europe or what ever and have done with it.

The use of asset allocation and tactical allocations will produce a very different result over the time period your suggesting.

Jim.

mercman said:

Wish more people would realise this is fact not persons out there trying to act GOD in relation to their market knowledge. In fact working on historical facts really means that know damn all.

Click to expand...

I think basing one's future investment decisions on economic history is a better base than basing your decisions on blind faith.

'Stock markets always go up in the long term'.

unfortunately they don't.

onq said:

I'd be more interested in who is buying what right now.

ONQ.

Click to expand...

Yes me too.

I like large mega-cap stocks in defensive industries like pharmaceuticals, telecoms, consumer staples.

Those on decent yields of 5%+ which have had major regression below the mean in terms of P/E valuations.

i.e. the parts of the indexes which aren't overvalued cyclical trash.

Jim2007 said:

Actually it's not!!! Valuation does play a part in the equation, but there are others and asset allocation is one of the primary ones.

You make the assumption in your analysis that what you call "Index Investors" simply blindly just buy an index and carry on. Based on my experience, I would say that a majority of what you call "Index Investors" are in fact practising an asset allocation strategy using index ETFs as an easy way to execute the strategy. That being the case, they would not as you suggest be pumping money into over valued indexes, but would in fact be at that point putting money into other asset classes.

Furthermore, more actively managed portfolios tend to make use of sector index ETFs so that they can make tactical allocations over and under weighting sectors based on valuation and expected performance. They don't simply buy the S&P 500 or the MSCI Europe or what ever and have done with it.

The use of asset allocation and tactical allocations will produce a very different result over the time period your suggesting.

Jim.

Click to expand...

Jim, I agree asset allocation is exceptionally important to an investor, probably the most important factor above the need to keep fees low in determining overall investment returns.

However, this does not detract from the point that overall indexes contain a number of overvalued sectors as well as undervalued sectors. On this basis buying the overall market as based on emperical evidence suggests that the market as a whole has further to grind sideways before becoming exceptionally cheap (the CAPE is still way too high and we are way too early to be entering a new bull market in the FTSE, S&P 500 etc).

In buying the overall market indexes, starting valuation is everything. Everything.

Buying individual sectors through ETFs, I agree is a good move. Many sectors I see as cheap on valuation (pharma, healthcare, telecoms) or have a secular reasons to invest (ie oil and gas as a result of demand/supply imbalances).

So I had a look at this link [broken link removed]

And in true company accounts style I started reading from the back and found that page 21 presents the return on the S&P 500 since 2000 based on a price only index.

To be clear a price only index simply tracks the change in share prices and excludes the returns from dividends.

Yet on page two of this document it is explained that dividends account for 4.5%pa of the total return from stocks some 45% of the total return over the last 100 years.

This misleading representation of facts has to call into question the validity of the claims made and would certainly mean that the document isn't of a standard suitable for publication in a respected finance journal.

Draw your own conclusions readers

Marc said:

So I had a look at this link [broken link removed]

And in true company accounts style I started reading from the back and found that page 21 presents the return on the S&P 500 since 2000 based on a price only index.

To be clear a price only index simply tracks the change in share prices and excludes the returns from dividends.

Yet on page two of this document it is explained that dividends account for 4.5%pa of the total return from stocks some 45% of the total return over the last 100 years.

This misleading representation of facts has to call into question the validity of the claims made and would certainly mean that the document isn't of a standard suitable for publication in a respected finance journal.

Draw your own conclusions readers

Click to expand...

Pretty much the same conclusion from the FPA Journal in 2006 -


(need to register to download)

Some of the salient points -

As a profession that has spent decades establishing itself in the midst of one of the greatest bull markets in history, it is understandably difficult for financial planners to conceive of the possibility that the markets of the future might be fundamentally different from those of the past. Although we all have repeated the ubiquitous phrase, "past performance is not an indicator of future results," we produce financial plans that are predicated on historical average market returns, and then try to design portfolios that will be most likely to match those long-term averages.

However, since March of 2000, it is probable that most financial planners have delivered a level of investment performance that is far below the assumptions made in their clients' financial plans at that time, even if the planner had used "reasonable" historical averages rather than the remarkable returns of the 1990s.



This article proposes that strategic asset allocation is not the most desirable strategy for portfolio management during secular bear markets. During these periods of long-term market returns that underperform historical averages, the traditional passive strategic "rules" for managing client portfolios must be reconsidered.

The authors will present evidence that suggests long-term market cycles do, in fact, exist. The article will then present four alternative active management strategies that are currently considered to be "high risk" strategies by the planning community (often because they "risk" substantially underperforming their relative benchmark), but may actually deliver significantly better returns for clients in difficult markets. Finally, the authors will discuss the phobic response to active management strategies in the advisor community and consider the financial planning and business implications of a secular bear market.


Conclusion


The key point of this article is that relying solely on a passive strategic portfolio designed to produce near-benchmark returns in a secular bear market will do nothing but guarantee that clients will underperform long-term expectations for an extended period of time and make it likely that they will fail to achieve their financial planning goals. In a secular bull market, like the period from 1982 to 2000, active investment strategies were not necessary to achieve goals—benchmark returns were more than adequate to achieve the desired and required long-term rates of return. In a secular bear market, however, employing active investment strategies like the ones discussed here, in combination with other financial planning recommendations, may be the only route by which clients can actually succeed.
　
Unfortunately, academics have struggled to demonstrate the value of active management strategies over the secular bull market of recent decades (and consequently, many readers of this article may dismiss it outright). Yet we posit that the potential results of these strategies may be inherently different in secular bear markets, and there is simply an inadequate amount of data from such prior markets (for example, 1965–1982) to clearly measure the success of these strategies. Furthermore, some would contend that financial markets are different enough now than they were in the past that such data and results might only have limited value, anyway. Ultimately, the authors leave the question of deeper exploration of historical results of these strategies to future writing and research. The bottom line is that if we are in a secular bear market, financial planners might consider some of the investment strategies discussed here, which deliberately seek not to produce portfolios with benchmark-like returns that would fail to achieve client goals.

Click to expand...

Every investor should review the table on page 4 that shows the P/E level on which secular bull markets end and secular bear markets end.

The USA 2000 bubble had a market P/E of 42 a level unheard at the end of previous secular bull markets (typically a P/E in the tens or twenties).

Likewise previous secular bear markets finished on P/Es of 5-12 times.

This implies that the 2000 bubble bust will take a significant time to play out as it was the largest stock market bubble ever recorded (except for Nikkei in 1990).

Likewise the current market hasn't bottomed out at a level anywhere near 5-12 times (except for certain value defensive stocks) to deduce that it is yet time to return to market indexes.