Good piece in today's Barron's
online.wsj.com
A Long View
Recent maps of the market don't show the whole picture
By JAMES T. KAHN
Who's ready for a terrible bear market lasting a decade or more? Not the general public, many of whom still think a fair sampling of historical stock-market trends can be viewed in the last 20 years. These people will be surprised. A 20-year horizon has led them to believe in platitudes that have only begun to go wrong: "You can't time the market," "buy and hold," and "bear markets tend to be brief."
Brief? From 1966-82, the Dow lost an average of 1½% a year for over 16 years-in nominal terms. But in real terms, prices of homes, gasoline, cars, and nearly everything else increased by a factor of eight during this period of record-setting inflation; a dollar put into the stock market in 1966 could buy only 12½ cents of goods by the time it came out in 1982.
This 1.5% annual loss was, in real terms, a loss of 12% a year for 16 years. That's a bear market. The downturns in 1987 and 1990 were not bear markets in any meaningful sense. If you went to the Himalayas for a few months, everything was fine when you got back. Those were bear markets like Grenada was a war.
"But the inflation and high interest rates of 1966-82 were an aberration," they say. True, which means that the great reason for our last bull market -- a gradual disappearance of inflation and high interest rates -- can't help us now.
American history since 1792 consists of nine bullish eras averaging 10½ years and eight bearish eras averaging 14½ years. The eight bearish eras -- 1802-29, 1835-42, 1847-59, 1872-77, 1881-96, 1902-21, 1929-42, and 1966-82 -- yielded average annual returns of minus 5.88%, before dividends, but also before inflation. This occurred in what -- so far -- has been the most successful national economy in history. If our first eight bull markets were followed by eight horrible multi-year declines and our ninth bull market was by far the greatest of them all, in terms of total percentage gain, could a new bullish era be starting already? Only if human nature has changed.
Just recently, a Barron's cover story ("John Neff's History Class," Sept. 23, 2002) offered a "history lesson" from a wise old sage who'd ostensibly seen it all, John Neff. It began, "Wanted: a few gray hairs." But gray hairs are not enough. No one alive is old enough to understand the true market patterns from personal experience. The last two mega-bull markets were extraordinarily long, and the last two mega-bear markets were extremely unusual.
In the Great Depression, the initial decline was so steep (89% down on the Dow) that it finally had to bounce in July of 1932, which was why the market didn't have its usual five-year decline. The market did fall five years in a row in the 1966-82 cycle, in real but not nominal terms. That five-year decline was masked by inflation. As a result, a platitude widely repeated nowadays is that "the markets almost never fall three years in a row." Some note that they fell four years in a row from 1929-32 and 1939-42, but those are supposed to be aberrations.
In fact, markets typically fall five years in a row, and they would have recently, except for those two extenuating circumstances. The S & P (or its reconstructed equivalent) fell five years in a row from 1825-29 (inclusive). It fell seven years in a row from 1836-42, five years in a row from 1853-57, and five years in a row from 1873-77. Look at the charts. The S & P fell four years in a row from 1881-84, five years in a row from 1892-96, and five years in a row from 1910-1914, and every one of these declines was part of a longer bear cycle.
Great Britain and the United States are the two empires that we know -- now, with hindsight -- were the greatest empires of the past 400 years. The British charts, covering the last four centuries, are peppered with five-year declines. Since most people don't know this ever happened, of course they don't think it can happen again.
This sort of widespread denial seems to stem partly from the fact that a lifetime often consists of only three market cycles. Since they alternate, we believe in the most recent one and the one from our youth, and dismiss the non-conforming one in the middle.
For example, imagine John Q. Public, born in 1855, who started investing in 1881. He ran smack into a 15-year bear market. The bull market spurt that followed lasted only six years; stocks then traded sideways to down for 19 years. Although our nation had grown into a great superpower in his lifetime, he went to his death distrusting stocks. John Q. Public Jr. would have had a similar view. He might have been born in 1876 and bought his first stock in 1902. The next forty years, taken as a whole, did nothing to calm anyone's fear of equities. But John Q. Public III, born in 1916, encountered two misleading trends: the unusual length of the 1942-66 and 1982-2000 bull markets, and the extreme inflation of the mega-bear in between, during which nominal returns looked so much better than real ones. Many investors of his advanced age are still heavily in stocks.
Unfortunately, there are other, equally nasty cyclical factors at work this year as well, such as the powerful "Election Cycle." Nearly everything bad that has happened in the market since 1802 has happened in a mid-term year. When end-of-the-century stock-market madness gripped this country, the collapse didn't come until 1802, two years into Thomas Jefferson's first term. The canal bubble burst in 1825-26. The Great Depression of 1837-38 is now only our second greatest ever -- that event took place in a mid-term year, although much of the stock-market damage was done in the years before and after it.
That bear market finally ended with the Panic of 1842, in which the market dropped another 30% and nine states defaulted on their bonds. Then stocks rallied 74%, right into the election of Polk. Americans saw a 36% decline in 1853-54. The Banking Crisis of 1857-58 ended with the failure of 18 New York banks and a 46% decline. All these disasters occurred in mid-term years. So did the Gold Panic of 1869-70 and the Depression of 1873-74, which caused the New York Stock Exchange to close for ten days. The Panic of 1890, and the greater Panic of 1893-94 led to another Depression -- all mid-term years.
After end-of-the-century stock-market madness once again gripped the country, everyone was surprised by the savagery of its collapse in the mid-term year of 1902. World War I broke out in 1914. Notice, however, that the turmoil preceding the Civil War (1860) and World War II (1940) was as bad or worse than that preceding World War I, and yet the market actually rallied into the election year both times! The cycle seems more powerful than world events.
More recently, there are ugly downturns in 1926, 1930, '34, '38, '42, '46, '62, '66, '70, '74, '78, '82, '90, '94, and 1998. And 2002, whose final low may still be ahead.
There will be ways to navigate through this mess. And three or four decades from now-after the current mega-bear and the next mega-bull-watch carefully as the next mega-bear is careening to a close. By then, most old-timers who started investing in 1999 will have developed a lifelong suspicion of the market. That's when you pounce! |
