TimingCube - Cyclical and secular bear markets - cyclical markets,secular markets,bear markets,economic cycle,cyclical sectors

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Signal Update

Current Signal Performance as of

Signal Type	Trade Date	Index	Return since issued
		Nasdaq 100
		Russell 2000
		S&P 500
		QQQQ

Cumulative Returns since First TimingCube Live Signal () as of

Index	Long Only	Long Only with Margin	Long & Short	Long & Short with Margin	Buy & Hold
Nasdaq 100
Russell 2000
S&P 500
QQQQ

Note: QQQQ returns are included for continuity sake.

Market Update

Markets moved higher this week and recouped some of the losses experienced since mid-April. Most of the gains came on Wednesday, the day after the Federal Reserve increased the funds rate by 25 basis points to 3.00% as had been widely anticipated. It should be noted that the market's rise this week was accompanied by volume that was relatively subdued. Daily volume for the Nasdaq Composite never topped 2 billion shares and was one of the lowest of the year on Friday. This shows that there is still reluctance on the part of instutional investors to buy aggressively.

Among the major indices we follow, the Nasdaq 100 and Russell 2000 posted weekly gains of 2.48% and 2.96%, respectively. Both indices remain below their 200-day exponential moving average (EMA). As for the S&P 500, it gained 1.25% on the week. It finished above its 200-day EMA and below its 50-day EMA. Our active Sell signal remains in effect.

Trend Timing School

Cyclical and secular bear markets

We have introduced bear markets in the October 31, 2003 article entitled "The psychology of bull and bear markets", in which we also presented our definition for them as the 10-day and 200-day exponential moving averages (EMA) crossovers. There are many other yardsticks used to detect bear markets, such as a drop of over 20%, but most describe so-called cyclical markets, which last on average from a few months to a couple of years. Most people are not aware that beyond these typical bull and bear market cycles there is a longer and stronger type of market mega-trend at work: the secular markets. Because they can influence investor behavior and markets for decades, secular markets are well worth studying and understanding.

The "cyclical" terminology is somewhat confusing and misleading because secular markets go through cycles too, with alternating bulls and bears. The reason cyclical markets are called cyclical is that they are correlated with the fluctuations of the economic cycle, which lends its name to many things such as cyclical sectors, cyclical stocks, and cyclical bull and bear markets. The economic and stock market cycles are inexorably intertwined, with the stock market normally leading the economic cycle, as bear market bottoms generally occur before the economy reaches full recession stage, and conversely, bull market tops precede full economic recoveries, as detailed in the August 13, 2004 Trend Timing School article.

Secular markets on the other hand are only seen with the very long view because they usually last between eight and twenty years. The terms secular comes from the Latin "saecularis" meaning of an age or generation, which also explains why they are sometimes called generational markets. The most recent completed secular cycle was the bull that lasted from 1982 to early 2000. Not very many investors are old enough to remember the secular bear that preceded it, from 1966 to 1982 (and the others would rather forget about it). What causes secular markets is not as clear as what drives cyclical ones. Market historians say secular bear markets are due primarily to extended periods of deflation or inflation. As seen during World War II, the Korean and Vietnam wars, it appears that major armed conflicts can have a significant influence as well. As usual, investor psychology has a lot to do with these cycles as well. The growing enthusiasm for the stock market that develops over the course of a secular bull inevitably leads to the speculative passion which, while delivering massive gains for one generation of lucky investors, also creates the massive overvaluations that then take another generation to unwind until markets reach the other extreme of investor capitulation and market undervaluation.

Secular bull markets

Secular bear markets

1896-1906

10 years

1906-1921

15 years

1921-1929

8 years

1929-1949

20 years

1949-1966

17 years

1966-1982

16 years

1982-2000

18 years

2000-?

? years

By saying that the last secular bull market ended in the year 2000, the implication is that since then we have been in the early stages of a new secular bear market. How can we know this and stay true to our "no predictions" mantra? The market action since the stock market bubble burst tells us unequivocally that the secular bull is over for failing to continue to meet the higher tops and higher bottoms rule for sustained generational movements. The cyclical bear that reached a low during October 2002 did excessive damage to the secular bull, and the cyclical bull that followed and lasted through the end of 2003 failed to set new highs. Note that a cyclical bull is also called a bear market rally (a cyclical bull during a secular bear). If you believe that 2000 marked the end of the last secular bull market, by definition that makes 2000 the beginning of the secular bear market we are now in.

The reason that we believe it is critical for any investor to be cognizant of these mega-trends is that they dictate important changes in market patterns which affect how one invests. First, the notion that you can be both in a bear market and bull market at the same time is counterintuitive. It is simplest to remember that during a secular bull market, cyclical bulls tend to be longer and stronger and expected to reach new highs, but cyclical bears tend to be shorter and weaker, often more of a consolidation phase than an outright bear. These are the periods when Buy and Hold investing is rediscovered as the latest and greatest invention, and makes a generation of investors geniuses. Then come the secular bear markets during which the opposite prevails, with cyclical bears frequently sharp and savage moves to new lows, and cyclical bulls shorter and weaker consolidations. You don't want to be a Buy and Hold investor during a secular bear.

Just because no one remembers does not mean we should view the 2000-2002 bear market losses as unique, or even rare in frequency and amplitude. Since the stock market has a long-term positive bias, long term charts always look like a continuing up trend, with a few interruptions. Unlike secular bull markets which always end much higher than they start, secular bear markets do not typically seem to lose much, when looking at absolute values. We mentioned the 1966-1982 secular bear which, as discussed last week, ended more or less where it started, in absolute terms. It generally takes a real value chart that compares "constant dollar" prices to notice the real damage inflicted by these very long bear cycles. See the long-term, constant dollar chart below.

Long-term market in constant dollar

Unlike the losses incurred during a cyclical bear under a secular bull, which are generally recouped within a couple of years at the most, losses suffered during secular bear markets can take ten, fifteen, or twenty years to win back, just to get to break-even!

Now more than ever should we heed our Model's Sell signals. Every downtrend it detects may not develop into a big one, but we simply cannot afford the risk of being long the stock market during a secular and cyclical bear market combination.

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