Top Gun FP Client Note: A Secular Bear Market
NOTE: Every week I write a Client Note for my clients. For a limited time, I am allowing non-clients to sign up and receive the Client Note. You can sign up at the top right hand corner of the website. Here is this week’s.
We’re halfway through a secular bear market in equities.
– David Rosenberg
, Chief Economist, Gluskin Sheff & Associates, on CNBC’s Squawk Box, July 7
Very few understand that securities markets alternate between very long term bull and bear trends which are the result of large macroeconomic, political, technological, cultural and geopolitical forces. This trend has been in play in US securities markets at least since the beginning of the 20th century.
A secular bear market from 1906 to 1921 was followed by the roaring 1920s. The speculative excess of that decade gave way to The Great Depression and a secular bear from 1929 to 1942. In the wake of WWII, the United States economy surged, pushing the US to international prominence and driving a secular bull market from 1942 to 1966. That was followed by a period of malaise from 1966 to 1982.
The period from 1982 to 2000 witnessed a spectacular, liquidity driven, secular bull market. Most of us came of age as investors during this time period and the philosophy of buy and hold gained prominence.
Since 2000, however, the US stock market has stagnated. In fact, the peak in the S&P 500 reached in October 2007 was not notably higher than the peak from March 2000. The 2000s have been a lost decade for stocks (see, for example, “The 2000s: Looking Like Another ‘Lost Decade’ For Stocks”
, Top Gun FP, March 26, 2008). That’s because I believe, like David Rosenberg, that we are about halfway through a secular bear market – the inevitable result of 20+ years of easy money and fiscal irresponsibility.
This also why the strategies that worked from 1982 to 2000 haven’t worked for the last 9 years. To extrapolate permanent investment principles from that unique period of investment history is to commit the fallacy of hasty generalization
. Buy and hold works when everything is going up but is a loser’s game when most things don’t. Alternative strategies are required to prosper in secular bear markets.
Investors have to be willing to trade more frequently and opportunistically. They need to learn about and become comfortable with betting against the market via shorting. They have to be willing to consider alternative investments like precious metals and other real assets. They also need to lower their expectations and realize that making money is much harder in a sick economy without growth than it is in a healthy, expanding economy. Capital preservation is a more realistic goal during these tough times.
While the US economy stagnates, an economic miracle continues in the unlikeliest of places: Chile. Now ranked as the 6th most free economy
in the world (the US is tied for 8th), Chile has quietly experienced steady economic growth for the last 30 years.
50 years ago the University of Chicago began an exchange program with the Catholic University of Chile. Chilean students took classes with Chicago School economists and many went to the United States to study economics. In 1975, after an economic catastrophe including 500% inflation caused by Socialist President Salvador Allende, who printed money to finance his spending plans, General Augusto Pinochet turned to Jose Pinera, a student at the Catholic University in the 1950s and then a Professor of Economics at the university, and other so called “Chicago Boys” to deal with the economic crisis. Milton Friedman himself visited Chile in 1975 and explained his views to President Pinochet.
As the Minister of Labor and Social Security from 1978-1980 and the Minister of Mining from 1980 to 1981, Pinera and his team of Chicago Boys undertook a radical restructuring of the Chilean economy. They privatized the nation’s social security system, created a private health insurance program, reestablished democratic trade unions and established constitutional property rights in the mining industry. Chile’s privatized Social Security system is the envy of the world, fully funded in private accounts and amounting to more than $120 billion, about 80% of Chile’s GDP. As a result, after a 0.9% annualized per capita growth rate from 1810 to 1983, Chile’s growth rate has surged to 4.3% for the last 20 years.
Following in the footsteps of the great Jose Pinera is Chile’s current Minister of Finance, Andres Velasco. Velasco earned a bachelor’s degree in Economics and Philosophy from Yale in 1982 and a Phd in Economics from Colombia in 1989. For most of the 1990s, he taught economics at NYU and did the same at Harvard from 2000 to 2006 before returning to Chile to become Minister of Finance.
In 2006, Velasco returned to a booming Chilean economy, the result of surging copper prices. Chile is the world’s leading copper producer and state owned Codelco, the world’s largest copper producer, was raking in profits. Government coffers were fat and the people demanded social programs and other goodies.
Velasco, however, insisted that the annual budget be set based on a more conservative estimate of the price of copper, not the current price. The resulting surpluses would be invested in a rainy day fund. Tens of thousands of students protested in the streets in mid-2006, seeking free school transportation and education reforms. In August 2007, Chile’s top union leader called a national strike, accusing Mr. Velasco of “declaring war” on workers by resisting wage demands. The protests ended in street fights and the arrest of hundreds. In September of last year, protestors broke into a presentation by Velasco carrying an effigy of him and shouting “The copper money is for the poor people.”
But Velasco had experienced at first hand the economic catastrophe of the 1970s and prior boom and bust cycles based on commodity prices. “This is a movie that may be novel to some Americans, but this is a movie that people in other places of the world, Chile included, know we have seen. This is a cycle that needs to be ended. We have been out to show that a Latin American country can manage properly, and not mismanage, a commodity cycle. You save in times of abundance, and you invest in lean times.” Velasco was steadfast in his principles.
Last year, the copper market started to crash along with the global economy. The Chilean economy ground to a halt. But because of the rainy day fund accumulated during the fat years, the Chilean government has been able to invest in the economy and stimulate it. As a result, Chile’s economy is expected to experience only the mildest of recessions. Velasco, who set out as a youth on a quest “to understand how did this happen [to Chile] and how do we make sure it will not happen again”, was vindicated. After being much maligned, Velasco and Chilean President Michelle Bachelet have seen their popularity surge in the last year.
If only California and The United States were more like….. Chile. Who ever thought anybody would say that? The principles of sound economics have been around for hundreds of years now. The logic is rigorous and the historical evidence convincing. Really, it’s nothing more than common sense. At least we can be encouraged by Chile’s example.
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