Cyclical Or Secular: The Bull-Bear Debate?

In our last issue we wrote that the constructive action in the US equity market, as well as several other foreign bourses, appeared to possibly be the beginning of a new secular bull market. Secular in this case means long term although the market does appear to have religious implications at times.

Some of the dynamics have changed since the end of 2009, but the gist of the comparison is still valid. One of the more glaring factors is interest rates. The reason for hat outsized mortgage rate was Ronald Reagan’s request of then Fed head Paul Volcker to raise the fed funds rate to 20% (it now lies at 0.25%) to whip the double digit inflation that began in the seventies.

Often times it is not where rates are, but where they are headed that creates business activity. As those high rates began to fall they became economic fuel for the baby boomer generation. Below is a long term chart of the 30 Year Treasury Yield which you can see dropped from 14% in 1982 to a low of near 2.5% at the end of 2009. As interest rates fall bonds rise and this has clearly been a 30 year bull market for bonds. There is much talk currently that the blue trend line is about to be broken and the bond bull market will end. We tend to disagree as we feel at some point the Fed will redirect its energy from inflating assets to keeping rates low, as Japan did in the 90’s in an attempt to spark a struggling economy. Did you know that the Nikkei 225 is at the same level it was in the mid 80’s? No progress for 25 years! Now that is a secular bear market.

 

Reagan also instituted tax cuts for individual and businesses with the top bracket dropping from 70% to 50%. With the budget issues of the federal and state governments tax cuts do not appear to be on the horizon. Look at the divisive nature keeping the Bush tax cuts created for Congress and the country late last year. Reagan also reduced government spending and government regulation during his tenure. As I entered the investment world later in the eighties the outstanding federal debt was a constant concern for investors at 40-50% of GDP. Today our outstanding debt nearly matches the annual GDP of the nation.

Another hurdle for the secular bull to overcome is the aging of the baby boomers. This group born in the fifteen or so years following WWII has been the most dominant demographic group in our country's short history, maybe in world history. As they entered the workforce the role women played as homemakers gave way to two-income households. The middle to upper middle class grew extensively in numbers and productive employment years to a period where they stop accumulating assets and begin taking distributions from them. Generations X and Y are smaller in size and create the concern that their contributions to Social Security will not cover the benefits the Boomers are penciled in to receive.

So the table argues that this is a cyclical bull market within the confines of a secular bear market. As we have mentioned consistently in the past the last thing you want to do is tell the market what it is going to do. It is okay to converse/write about possibilities, but absolutes tend to get you in trouble. If this is the beginning of a new secular bull what dynamics will replace a productive baby boomer generation, falling interest rates, and tax cuts?

Three things jump out at us 1) is the growing number of developing nations in the world and their growing middle classes. The ability for them to mimic the learning curve we developed and refined over the last couple of hundred years around technology, infrastructure, policy making, resource utilization, etc. and actually improve upon them could bring a world where they eventually out consume us. This group could be the buyers of our goods and services that replace our falling domestic consumption. 2) The financial crisis and attendant recession forced corporations into an increased efficiency mode which involved fewer people doing more work. This is a key factor in analysts estimating all time record S&P 500 earnings for 2011. If this productivity boom is a new paradigm it could impact profit margins and the bottom line for several years. 3) An innovation boom involving the internet, wireless, and other technology could leverage the previous two factors, maybe exponentially. Hard to tell the impact hundreds of millions of people becoming technology literate will do to the world economy. We do not remember many experts predicting the dotcom boom and maybe there is another “under the radar” technology explosion in the wings. Just hope it ends better than the dotcom thing did.

We believe that at some point this year or early next the secular bull market question will be answered. With the events in Egypt this past week the financial crisis hangover appears to be lingering if not intensifying. We know one thing for sure is that the world’s financial and economic policymakers/leaders have their work cut out for them. It does appear to be one grand experiment with few dull moments.

Chart Spotlight

We have written regularly for the past decade about manipulation that occurs in our markets. Early last decade much of what we and others wrote about this topic was summarily dismissed as typical conspiracy conversation. The last few years have pulled a few of the layers back from the onion revealing some of the funny business that appears to have gone on, a good crisis has a tendency to do that. Last Tuesday a relatively odd thing took place in the stock of IBM (dark line on chart). About an hour before the close with the stock trading in the $161 area, it all of a sudden traded above $164 (thin line in oval) for no apparent reason. Is it possible that move was enough to spark a computer generated program trade in the S&P 500 futures driving them up several points in short order? There has been no hard evidence that the IBM trade ignited the S&P rally, but it sure appears fishy. This may seem inconsequential, but adds to the growing evidence in our minds that the market is not always a level playing field. Last May a few days after a very constructive multi-month rally (not unlike the last few months) the Flash Crash (a thousand point intraday Dow drop) occurred. It is situations like this that lead us to believe that the regulators may not be able to prevent another one of these anomalies from occurring. Hope we are wrong.

  

Did You Know

Housing Numbers - $23 billion of adjustable rate mortgages (ARMs) are expected to be reset from their initial interest rate in January 2011, the smallest monthly total that will be reset nationwide in 2011. The peak amount of resets this year will occur in August 2011 when $40 billion of ARMs will end their initial rate period, i.e., the length of time that the original ARM interest rate remains unchanged. 50% of the 75 million homeowners in the USA either have an outstanding mortgage balance on their primary residence that is less than 50% of their home’s current fair market value (e.g., mortgage debt of less than $100,000 on a $200,000 home) or they have no outstanding mortgage debt at all. 1,046,762 homes were seized by lenders in calendar year 2010 as a result of foreclosure, an average of 2,868 per day. There are 75 million homeowners in the USA, 24 million of which do not have any mortgage debt on their homes (source: RealtyTrac, Census Bureau).

Final Thought

“It is amazing what can be accomplished when no one specifically gets the credit” –

John Wooden…probably speaking to Congress