Rudi's View | Sep 19 2012
By Rudi Filapek-Vandyck, Editor FNArena
I am sure the question has crossed your mind in weeks past: is this it? The moment upon which we will all look back next year, and the years thereafter and say: hey, that was when the bull market of 2012 started?
Bell Potter's MD of Wholesale, Charlie Aitken, certainly thinks this is the case. So does Morningstar's old hand Ian Huntley. Clifford Bennett, nowadays White Crane Group, has been screaming bull! bull! at the top of his lungs ever since global equity markets started rising in March 2009.
Before we look into the merits of these predictions, allow me to take you all back to my favourite reference for what we are experiencing today: the sixties and seventies. Not that history can provide us with all answers about the future (it cannot), but it does provide us with a framework and with some ideas about what is possibly happening today. To quote Mark Twain: History doesn't repeat itself, but it does rhyme.
As you all can see from the chart below, which has featured prominently in about every presentation I have given over the past five years, things weren't exactly running smoothly between 1966 and 1981. We had several strong rallies of 20% and more during those 15 years -one year we even had a rally of 76%- but these upswings were all followed by sell-offs of up to 45%. At the end of the period, in 1981, the Dow Jones Industrial Average had once again sunk well below the level of 1966. Finally, it took one more Big Rally -of 38%- to push US equities through resistance and to never look back again.
Most of us will be old enough to remember what happened in the early eighties. A hapless Jimmy Carter got voted out as US President. He was replaced by the amicable B-actor Ronald Reagan, who managed to lift America's spirit when everything seemed to go the USSR's way. The Federal Reserve had just welcomed Paul Volcker as Chairman in 1979, ready to declare war on inflation. In hindsight, the changes taking place seem so easy to recognise, but back then nobody was interested in the recovering share market. Remember, in 1979 Time Magazine had published its now forever famous "The Death of Equities" edition.
If you look on the chart below, at the time of the Time Magazine death cover, US equities had just finished yet another rally of 25% and were heading back to the bottom of the range. It would still take more than two more years before that bear-market ending rally would take place in 1982.
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Just like most of you, I assume, I was here in the sixties and seventies but, given my young age, I had other things on my mind than following financial markets from close quarters. But here are a few easy to draw conclusions:
– by the end of that period (15 or 18 years, depending where one places starting point and finish) general appetite for investing in equities would have been ab-so-lu-te-ly dismal as the extreme volatility throughout those years, without making any noticeable progress, would have worn out the last remaining snippet of hope and gutted even the last few standing perma-bulls. That infamous Time Magazine cover is all the proof we need to support that statement
– but also: every time the share market went through yet another rally, or made a fresh new start after yet again bottoming out at the lower end of the range, we can all be 100% certain there would have been at least a handful of commentators and equity strategists on the sidelines calling the advent of the next Big Bull Market
Even scholars of the 1930s acknowledge things had started to appear much better by 1935 and equities had actually staged somewhat of a come-back in the form of a 900 days rally before the overall environment unexpectedly turned sour again. This is why some experts maintain the 1930s period actually consists not of one, but of two separate bear markets. Just like some experts believe the bear market that started in the mid-sixties ended in 1976.
Let's not quibble about semantics or about exact timing. What all analysis about these two reference periods have in common is that conclusions are being drawn many years later, in hindsight. One famous saying about the thirties is that, ultimately, those investors who managed to pull out in time during the first bear phase, later got sucked in again and were then taken to the slaughter. I can only assume the same thing happened again in the seventies. It seems but a fair assumption to make. That's why, by the time Volcker and Reagan arrived (and Thatcher in Britain), nobody was interested. Too many false hopes and bitter disappointments.
Which takes me to the point I wanted to make: the conclusion whether a new bull market has started and whether the bear market that started in late 2007 (or March 2000 – depending where we put the starting point) has finally ended will only be made at some point in the future, in hindsight. Because at the start of market turnarounds, and during the upswings that ensue, nobody can comfortably predict what will happen at the end of the ride, when momentum slows down and things turn sour again.
One thing history shows, though, is that pull-backs outside the bear market (i.e. in a bull market) are more benign in nature and merely a pause in a long term, continuous uptrend. In a bear market, however, those pull-backs are more vicious and stronger in nature and they tend to push back equities to the bottom of the range, if not lower.
One could conclude that, from this point of view, it seems rather futile trying to announce the next bull market and the death of the bear, without knowing what the next serious correction will look like. Things are not made easier by the fact that upswings can last for a while, sometimes one full year or even longer, and so can the subsequent downswings.
It cannot be denied, however, there are some good arguments in favour of a new bull market. Overall despair among investors is high and market participation is very low. Even in the US -imagine!- as major indices are back at levels from early 2008 and within reach of their all-time record highs (including Nasdaq), investors continue pulling money out of the market and out of managed funds, and they have continuously pulled funds since the uptrend began in 2009.
Here's one thought that has remained on my radar throughout 2012: it really feels like there are not enough sellers left to push equities much lower.
Most investors who do not want to participate in today's market, no longer are. They have sold whatever there was to sell. They sit on the sidelines and wait, if they haven't abandoned the share market altogether. But the traders, and the optimists and those funds managers who allocate Australia's super funds to equities, they will push up prices, even at low volume. To get this market in a serious downward spiral again, we first need to get some serious volumes moving back into the share market. This might just be another reason as to why the next downtrend will be more telling than what is happening right now.
Meanwhile, there are plenty of anecdotes around as to how low investor sentiment has fallen nearly five years after global equities peaked in November 2012. Here at FNArena, we see investors leaving the database that have been in there since 2006. So… now they have given up, after six years of being a member?
Last week I met someone who's well connected in the high end property markets of Sydney and Melbourne. For two hours we spoke about wealthy Australians pulling money out of equities and out of bank accounts and investing in property instead, either via new purchases or via renovation and extensions. The theme throughout his observations was there didn't seem to be an investment logic behind these decisions as many "investments" were made at prices that seemed too high to ever attract a decent return, maybe even any return. Maybe the message here is these wealthy Australians too have lost all confidence in the share market? For all I know, they may even distrust the banks and the Aussie dollar and ultimately feel safest when they can see and touch the earth with the bricks and stones that contain their wealth?
Another financial services provider in Sydney told me recently the contribution of equities has now dropped to less than 6% of all trading volumes by his client base. One would be hard pressed to see that number fall much lower.
All these anecdotes suggest equities are most definitely out of fashion. Historically, this has been the ideal platform from which new bull markets emerge. What needs to be kept in mind, however, is that we can be pretty certain that when the market bottomed in April 1980 the situation would not have been different and yet, after a rally of 35% over the subsequent twelve months, equities again sold off by 24% in 1981. I am even willing to bet the situation would have been pretty similar in 1978 when the Dow bottomed at practically the same level as it did two years later in 1980.
There is also another approach that cannot be left unmentioned in this context and that is that while the US share market tends to go through extended bear market phases post periods of excess, historically the pain that trickles down onto the Australian share market is not as extensive as the US experience. Former Wilson Asset management stock picker Matthew Kidman, in his book "Bulls, Bears & a Croupier", argues that bull and bear cycles in Australia seldom run parallel with those in the US. The best evidence is the US equities' bull market ended in March 2000 while Australia's bull market started in 1992 and didn't end until November 2007.
Historically, writes Kidman, bear markets in Australia don't seem to last longer than five years which would put the start of the next bull market at around later this year/early 2013.
I would argue the past years certainly have shown US equities and the ASX200/All Ordinaries do not always trend in lock step. But this can also mean that while US equities could well officially rally above their previous bull market highs before year-end (which would make it, according to a widely used definition, no longer a bear market) this does not automatically translate into good news for Australia. Chinese equities, on the other end of the spectrum, still look very much in bear-territory and very ill indeed.
To make this matter even more complicated, consider the following: according to most experts (also my view) US equities entered a new bear market in March 2000. Yet, with ultra-low interest rates and ultra-loose monetary policy, global equities, including in the US, managed to squeeze out four years of renewed investor exuberance, until reality kicked in again. The key element, just as was the case in the 1970s, is that underlying problems hadn't been addressed properly (it can even be argued things got worse instead).
And that about summarises my view for where we are today. Yes, we've had four years of sideways, going-nowehere-in-a-hurry share markets after the 2008 disaster (at least: outside the US), but it's not like we have solved all our problems. In fact, it can be argued we haven't solved much, except that we discovered the virtue of excessive liquidity and we've started using it in spades. I still expect that at some point, the cans that have been kicked further down the road will come flying back into our faces. By then, all shall be dependent on where we are in the economic cycle and with financial valuations, et cetera.
Which is why investors should participate in the share market according to their own level of risk appetite.
Don't forget: compounding growing dividends is the key to true investment success in the longer run, while "All-Weather Performers" offer the best risk-reward in the share market when purchased at reasonable value. Mining and energy stocks, including industrial cyclicals, can be ideal to find higher rewards in a shorter time-span. Unless we are at the beginning of a new, sustainable bull market, of course, or a repeat of the 2004-2007 years.
Whenever in doubt: see all of the above.
(This story was originally written on Monday, 17 September 2012. It was published on that day in the form of an email to paying subscribers.)
