INVESTING FOR SURVIVAL IN A LONG BEAR MARKET
gold-eagle.com
Readers of my previous articles are aware that I am planning for a long bear market - much longer than nearly all investors, professional or not, are expecting. As a direct result of 62 years of serious study and hands on experience, I do not expect to see the end of this still young bear market. I can even conceive of it lasting throughout the lifetime of my young adult grandchildren. My view of a super bear has narrowed my thinking to basic investing fundamentals and the details of how to build and preserve assets through the many difficult years I see ahead.
Before we get into the main part of this essay, let me describe a few events that changed my entire investing life. The Cuban missile crisis that erupted in 1962 developed over a period of months and caused many thousands of families to build nuclear bomb shelters in their back yards. As the crisis mounted day by day and hour by hour, the stock market began to drop rather sharply. It caused me to make my first short sale - a few shares of a blue chip stock. My timing was horrible for it turned out that I sold on the exact bottom day in November 1962 when the nuclear standoff with Russia ended. Buying back those shares in a sharply rising market was an experience I'd like to forget. To paraphrase a famous quotation from Charles Mackay's epic book on The Madness of Crowds, "Investors go mad in crowds and regain their sanity one at a time."
In the ten years following this 1962 incident, the market went into a full blown bull market known as the Go-Go years which included the Nifty 50 stocks that needed only to be bought and never sold. Several mutual funds were organized to exploit speculative registered securities that could not be sold for a specified time period. When the mini-mania cooled, several of these funds literally went broke and investors lost their money.
The Speculative Sixties ended in the second greatest bear market of the 20th century. It started in the Spring of 1972 on the basis of an unweighted market index and ended in December 1975. Among the treasures I have from this period is a hand drawn 11x17 chart of 3300 unweighted weekly prices of NYSE-AMEX-OTC stocks. Unlike the major weighted indices that dropped 48-50%, this group dropped 64% over a nearly 3 year period. When the final bottom came in December 1975, it was not recognized by average investors, professionals or the media. It only became apparent after the new bull market was well into the Spring of 1976. That simple fact destroys the imbecilic "bottom picking" fad pervading Wall St. today. Forget this great lesson to your sorrow!
THE CASE FOR A LONG BEAR MARKET
Let's begin by reviewing some historic bears in the past 5 centuries. The Dutch Tulip Bulb Mania in the 1630's still fascinates modern readers. According to Mackay's book, this was not a minor affair involving unsophisticated peasants. It swept through all levels of society. Although there was nothing like today's stock exchange and adequate price records, we know that bulb prices reached a level where people were trading houses or acreage for a single admired bulb. Strangely, there was also an options market in tulip bulbs! When the bubble burst in 1637, it must have left widespread economic devastation throughout Holland. One can imagine that perhaps a full generation was needed to gain a full economic recovery.
We have a much fuller record of the South Sea Bubble that exploded on the London Stock Exchange about 1720. This was a full blown Ponzi scheme that had the backing of the London city council. A new stock company was formed to have a monopoly for all trading to the "South Seas." During the 1720-1722 period, the stock soared tenfold in price and collapsed when the bubble burst. It is reported that the King of England and Sir Isaac Newton both lost a substantial amount gold crowns in the scheme. The record also shows that every company on the London Exchange went broke.
Thanks to some remarkable research by Elliott Wave pioneers, we now have a continuous record of prices in the London exchange back to 1700 and coordinated with American stock prices since 1885. This consolidated price chart has made it possible, using Elliott Wave analysis, to connect all modern U.S. prices back to the 1720-22 stock bubble. It shows that, the bear market ensuing from the South Seas bubble lasted 62 years until 1784. At that point, a huge bull wave started which lasted for 216 years and ended in January 2000 at the top of the Dow Jones Index. This wave in Elliott terms was Wave III in a five wave Grand Supercycle Degree. Since January 2000, our bear market represents the start of Wave IV of the Grand Supercycle which may equal or exceed the 62 year length the Wave II bear that followed the London Bubble (1722-1784).
The top of the U.S. stock market in 1929 represented the end of Wave 3 of the lower Supercycle Degree. The 1932 bottom marked the end of Wave 4 and the beginning of Wave 5. This was the final wave in the 5 wave Supercycle Degree ending January 2000. It also marked the end of Wave III in the Grand Supercycle Degree. This well defined Elliott wave sequence is the basis for the very real expectation that our current bear market will be greater in depth and duration than the one following 1929.
Alan Newman, in www.cross-currents.net, has published dramatic charts, corrected for GDP, showing that the 2000 market peak was much greater in all measurable respects than the 1929 peak. On his great charts, the 1972-75 bear market that I endured shows up as a small blip between the two large peaks. This tells me that the current bear will be of unprecedented proportions. As a firm believer in the Elliott Wave Theory, I expect its predictions to be proven at the end of this bear cycle sometime in the next 100 years.
THE JAPANESE BEAR MARKET MODEL
Ever since World War II ended, conventional wisdom in this country has been that the Great Depression following the 1929 Crash could not and would not happen again. But every piece of historic or current information I have read in the past two years convinces me that it can and will happen. The quotes from our leaders just before and after the 1929 crash read today as coming from our contemporary spokesmen. The older group neither understand the problem or its solution and their words and actions are sadly being repeated today.
The current failure to adequately assess and respond to our economic problems is mirrored in the attitude towards the 13 year ongoing Japanese bear market. Our "experts" fail to see any similarity between our situation and theirs but they have plenty of suggestions for actions the Japanese should take to solve their problems.
The Japanese stock market has taken 12 years to drop from 39,000 to 10,000 yen. Their banks are mostly bankrupt and their consumers are not spending. Japan is in a deep depression with no apparent solution. This situation resembles closely that in the U.S. about 1937 when our economy was bogged down with no solution or end in sight. I know this very well because, at that time, I was in graduate school living on a $600 stipend per year. I do not like the thought but I have no difficulty whatsoever imagining this country in another deep depression for which it is totally unready to cope and defeat.
WHAT MAY LIE AHEAD
I have no crystal ball but I do a lot of reading in the financial media. The recent Enron failure may generate a chain of failures in our business and financial companies . I do read predictions of a massive financial failure whose probability is currently unknown. After a two year decline in stocks, we are now finishing a strong bear rally that will be followed by the second leg down in stocks. Sometime in the next two years of decline, the average "buy and hold" investor will add up his losses and decide to sell everything. It happened in 1974-75 and I see no reason why it won't happen again. That will lead to a massive market sell-off and panic that will lead to general fear and a major depression.
I saw this happening on a much smaller scale in 1974-75 and it left a very vivid picture in my memory. I confess that I am unable to imagine the scope and horror of the coming panic. It does lead me to suggest some very unconventional ways to protect assets in the once-in-a-century bear market I envision. My present thoughts are presented below.
RELY ON TANGIBLE ASSETS
Serious times ahead require the use of very basic thinking about asset protection. Fully paid for real property and precious metals in physical form are at the top of the list of assets that should survive conditions causing other asset classes to fail. Substantial equity in your home or income property plus some physical gold and silver should form the base of your asset pyramid. We will not discuss these items further and will present ways to augment them with selected paper assets in which we have some confidence.
In a recent gold-eagle article, we suggested a group of portfolios with varying ratios of short term treasuries, precious metals and short mutual funds. To that list we will now add a fourth category - REIT mutual funds. To simplify this presentation, we will omit the necessary treasury cash reserves and consider the use of the other 3 major categories.
Mutual funds holding a diversified portfolio of individual equity REIT stocks own, in stock form, tangible real property of all types. In the first two years of the bear market, the prices of the REIT stocks and the funds that own their shares have proven to have good stability relative to nearly all other asset classes. The stock prices are supported by their very large mandatory dividend payments so we expect their relative stability to stay good even thought they do drop in the continuing bear market. But we have available a way to support this portion of the portfolio if needed by selling short the stock of a diversified REIT exchange traded fund (ETF), one example being stock symbol ICF.
We continue to use Precious Metals funds as a very important means for asset growth in the event of future inflation. Like REITS, these funds have shown very good price stability in the bear market so far. And again, as with the REITS, we can sell short a diversified closed end gold stock such as American South African (ASA) to protect gains.
PAST PERFORMANCE OF CHOSEN ASSET TYPES
Using a large mutual fund price data base, we ranked the REIT, Gold and Short fund groups separately over the full 37 month period from 12/31 /98 to 2/1/02. We picked the 3 top ranked no load funds for each portfolio group. Below we show the annualized average return of each fund group over the last 37, 25 and 13 month periods.
Note that the REIT funds are holding up well despite the small drop off recently. The gold funds are currently the strongest of all fund groups. The short funds had a slow start and all had losses in the months before the start of the bear market. However the more recent returns illustrate why they have been picked as a key holding in our plans. Note the steady improvement over the years for the average of the 3 fund groups.
The total portfolio of 9 funds, three from each group, can probably be owned and managed in a single brokerage account if desirable to minimize paperwork.
TYPICAL PORTFOLIO EXAMPLES
Using the performance data given above for the individual fund groups, readers can easily calculate the past performance for the above mixes or any others they wish to try.
Our 3 asset classes will provide immense diversification during bear market ups and downs. The REIT class should do well in rallies while the Short funds will excel in all bear declines. The Gold funds will continue to go either up or down as only they will decide.
Our one regret at this time is that we will not be here to witness the end results of either a lump sum or a dollar cost averaging campaign.
PORTFOLIO MANAGEMENT
With either a lump sum investment or a dollar cost averaging plan, it will probably prove desirable to rebalance the dollar ratios of the 3 groups, perhaps semi-annually. It is also probable that at some future time the gold funds will go through their own boom and bust cycle. In this event it would be advisable to consider a short hedge with a major gold stock to protect profits at the top. Use rebalancing for more modest fluctuations. Similarly, with the REITs, if they begin to enter their own bear market the use of a short sale of a REIT exchange traded fund should be considered.
FINAL COMMENTS
The author welcomes e-mails from readers at home and abroad both supporting or opposing his views. However, please note that he is unable to provide personal investment advice or to discuss the merits of individual mutual funds.
Robert B. Gordon Sc.D.
Sun City West AZ
rgordon145@aol.com
February 4, 2002 |
