TimingCube - Bear expectations - bear market statistics, secular bear market, actively managed ETFs, active ETFs

Signal Type

Trade Date

Return since issued

World

U.S.

Nasdaq 100
(QQQQ)

Russell 2000
(IWM)

S&P 500
(SPY)

Market Update

Stocks pierced through their 2008 lows this week, with the S&P 500 returning to levels not seen since 1997 by Thursday's close. Wall street was hit by more bad news Monday as Citigroup announced that it would cut over 50,000 jobs and retailers Target and Lowe's reported poor quarterly results, contributing to a 2.6% daily loss for the S&P 500. Stocks dropped further early Tuesday but were able to bounce off last Thursday's lows to close with slight gains. The next session proved to be a lot more challenging, as a spat of disappointing corporate and economic news weighed on sentiment: automakers General Motors, Ford Motor and Chrysler are on the verge of collapse and are desperately seeking a government bailout. Shares of GM and Ford are now trading at multi-decade lows. The minutes from the last Fed meeting showed that the central bank expects the economy to remain weak throughout the first half of 2009. The Consumer Price Index (CPI) dropped by 1% in October, causing some to raise the specter of deflation. And in the home building sector, housing starts hit their lowest level on record in October. This stream of bad news resulted in a big drop for stocks Wednesday, illustrated by a 6.5% loss for the Nasdaq Composite. The main indexes fell hard again the next day: the S&P 500 shed another 6.7% on heavy volume to close at its lowest point since April 1997. Seeking much needed stability, stocks were able to close the week on a more positive note Friday by recouping all the previous day's losses. The rally occurred late in the session after it was reported that respected New York Federal Reserve President Timothy Geithner will be the new Treasury Secretary under the Obama administration.

The Nasdaq 100 (QQQQ), S&P 500 (SPY) and Russell 2000 (IWM) respectively lost 7.97%, 8.20% and 10.96% on the week. All 3 ETFs remain located well below both their 50-day and 200-day exponential moving averages (EMAs).

For its part, our World portfolio posted a 7.89% loss this week. The portfolio consists of the 5 top-ranked world ETFs as of November 7, which marked the beginning of the current 4-week holding period. Please note that since we now have an active Cash signal, the World approach calls for selling your holdings if you follow the "Long Only" or "Long and Short" strategy. Only if you follow the "Buy and Rebalance" strategy should you remain invested in the top 5 ETFs, as the strategy calls for staying invested at all times. Please go to the "Our Service" page for all the details.

Our current Cash signal remains in effect.

Trend Timing School

Bear expectations

The S&P 500 is down nearly 50% from its October 2007 peaks, which puts this bear market decline in contention to be the second largest ever (the largest being the 1929-1932 drop of some 86%). Even the "perma-bulls" and other "buy and holders" are beginning to admit this could actually be a real bear market. Most investors have thrown in the towel and it feels like the capitulation phase is at hand. The pundits who called the bottom at -20, -30 and -40% are nowhere to be found, which just might be the best indicator that a bottom is actually being established.

All the traditional bear market definitions, such as a drop of at least 20% or the bearish crossover of two moving averages, have been met many months ago and the question has now shifted to how deep and how long of a bear market it is going to be. To place the current situation in historical context, we offer Chart 1 below. We use a logarithmic scale to plot the S&P 500 so the moves remain proportional in percentage terms. We can readily see that the current decline has already exceeded the 2000-2002 bear market, not only in percentage drop but also by establishing a lower low. In order for the long term support marked in red to be convincingly broken the markets would certainly need to stay below that level for more than a day, but if they do it will be a momentous event for market technicians.

Chart 1: 30 years of bull and bear markets

Another observation from the chart is that the bear markets during the 1980s and 90s were puny compared to the ones since 2000, both in percentage and duration. In case you struggle to spot them, there were two in the 80s (1981-1982 and in 1987) and, arguably, two more in the 90s (1990 and 1998) but they lasted but a couple of months and barely met the 20% drop criterion.

This leads us to the distinction between secular and cyclical market phases. The 18 years from 1982 to 2000 were the last secular bull market. While it was interspersed by cyclical bull and bear markets, bulls were oversized and bears were undersized by historical standards. Many market analysts have seen the year 2000 as the transition from secular bull to secular bear, and recent developments certainly lend credibility to their point of view. Secular bear markets, also called generational bear markets, have averaged 17 years in length since 1900. There have been three of them, not counting the one we might be in right now, and the last one on record was from 1966 to 1982. In the same time span there have been 4 secular bull markets which averaged 13 years.

Cyclical markets on the other hand are of much shorter duration. In the same 100 years, there have been some 24 cyclical bear markets lasting an average of about a year and a half for average declines of about 33%. The cyclical bull markets that separated them, on average, lasted just under 3 years and the market more than doubled in value.

The stock market always looks ahead and has been a reliable predictor of the economy. With new bear market lows being set the market is clearly anticipating a deeper and more prolonged recession than before. The market hates uncertainties. As long as there is renewed evidence that the global credit and economic crisis is spreading and worsening, with no clear and credible solution in sight, the bear market will go on. But if the economy and stock markets are somehow linked, could we use recessions to predict the end of bear markets?

Schwab recently published an interesting study of the correlation between recessions and the stock market. The chart below traces the stock market action around recessions from 1947 to 2002. It combines all of the 10 prior recessions into a single average line using S&P 500 readings for 12 months before and 12 months after the start of the recession. On average, the stock market peaked about 7 months before the recession began and it bottomed about 6 months into the recession.

Chart 2: Relationship between stock market declines and recessions

Source: Schwab and Ned Davis Research, Inc.

Still, one of the very encouraging messages contained in the study is that most bear market bottoms, and therefore the start of most bull markets, occur in the midst of a recession, when things look bleakest. The Schwab study also analyzed the market recovery from the recession lows and found that on average the S&P 500 had gained 38% one year after the recession bottom.

These patterns repeat throughout history with consistency, but what is not nearly as consistent is the wide range of time frames for bear markets and recessions as well as their varying depth. Averages completely hide this variability and tempt many naive investors to use them to time the market bottoms. Another good measure of how variable bear markets can be is the time it takes to breakeven, i.e. the time to reach the previous bull market top. During secular bull markets this happens very rapidly but during secular bear markets it can take many years. The record, so far, is 25 years following the 1929-1932 bear. At which point buy and hold investors should take notice that what we are currently experiencing does not appear to be your average bear market or your average recession.

Another key lesson students of the stock market ignore at their own peril is that bear markets take down all equities, the good and the bad. While bear markets always begin with the implosion of one particular sector (real estate in this case) it invariably dominoes into affecting all industry sectors. Safety can only be found in other asset classes, such as cash and bonds so far this time.

The main conclusions we extract from all these bear market statistics is that averages and probabilities can only give you a feel for what to expect, including some possible worst case scenarios, but provide little practical forecasting help. All of this goes to reinforce our long standing commitment to faithfully follow the market trends as the only viable approach, however imperfect it may be, to navigate the treacherous markets that we know lie ahead.

FAQ of the Week

Question: What are actively managed ETFs?

Actively managed ETFs, or active ETFs, represent a new category of funds which are effectively a cross between closed-end funds and open-end index ETFs. At TimingCube we have made no secret of our dislike of closed-end funds, see "Closed-end versus open-end ETFs" for example, and our enthusiasm for index ETFs. Actively managed ETFs are essentially open-end ETFs which do not track an index. And there lies the rub.

Ironically, the first actively managed ETF was YYY, the Bear Stearns Current Yield Fund which launched on March 10, 2008 and is already defunct. For the comical anecdote, the fund is now referred to as "why, why, why?" in the fund industry. As a result of YYY's demise, PowerShares is now claiming to have been the first to offer actively managed ETFs with the 4 funds they launched on April 11, 2008 (PLK , PMA , PQY and PQZ ). These funds are still trading as of this writing but they have not been setting the investment world on fire, to say the least. In the 7 months since inception these 4 funds have amassed an underwhelming $13.9M in assets, combined. Their performance as shown in the table below is nothing to write home about either (we intentionally left out PLK which is a bond fund and as such does not compare with the others).

Table 1: Actively managed ETF performance

PMA	-35.7%
PKY	-43.5%
PQZ	-53.4%
S&P 500	-39.5%

Regardless of past performance, the reason we do not like actively managed ETFs and do not recommend their use with the TimingCube system is that instead of following the broad market indexes for which we track trends, they use proprietary stock selection models. As a result, they lack the transparency, predictability, safety and low cost associated with index ETFs.

Warm wishes and until next week.

The TimingCube Staff

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