May 1, 2011 Monthly Update
Was the March 2009 low the end of a secular bear market and the beginning of a secular bull? Without crystal ball, we simply don’t know.
One thing we can do is examine the past to broaden our understanding of the range of possibilities. An obvious feature of this inflation-adjusted chart of the S&P Composite is the pattern of long-term alternations between up- and down-trends. Market historians call these “secular” bull and bear markets from the Latin word saeculum “long period of time” (in contrast to aeternus “eternal” — the type of bull market we fantasize about).
If we study the data underlying the chart, we can extract a number of interesting facts about these secular patterns:
The annualized rate of growth from 1871 through the end of March is 2.01%. If that seems incredibly low, remember that the chart shows “real” price growth, excluding inflation and dividends. If we factor in the dividend yield, we get an annualized return of 6.68%. Yes, dividends make a difference. Unfortunately that has been less true during the past three decades than in earlier times. When we let Excel draw a regression through the data, the slope is an even lower annualized rate of 1.71% (see the regression section below for further explanation).
If we added in the value lost from inflation, the “nominal” annualized return comes to 8.90% — the number commonly reported in the popular press. But for an accurate view of the purchasing power of the dollar, we’ll stick to “real” numbers.
Since that first trough in 1877 to the March 2009 low:
- Secular bull gains totaled 2075% for an average of 415%.
- Secular bear losses totaled -329% for an average of -65%.
- Secular bull years total 80 versus 52 for the bears, a 60:40 ratio.
This last bullet probably comes as a surprise to many people. The finance industry and media have conditioned us to view every dip as a buying opportunity. If we realize that bear markets have accounted for about 40% of the past 122 years, we can better understand the two massive selloffs of the past decade.
Based on the real S&P Composite monthly averages of daily closes, the S&P is 66% above the 2009 low, which is still 31% below the 2000 high.
Add a Regression Trend Line
Let’s review the same chart, this time with a regression trend line through the data.
This line essentially divides the monthly values so that the total distance of the data points above the line equals the total distance below. Remember that 2.01% annualized rate of growth since 1871? The slope of this line, an annualized rate of 1.71%, approximates that number. The difference is largely a result of the massive rally over the two years.
This chart below creates a channel for the S&P Composite. The two dotted lines have the same slope as the regression, as calculted in Excel, with the top of the channel based on the peak of the Tech Bubble and the low is based on the 1932 trough.
Historically, regression to trend often means overshooting to the other side. The latest monthly average of daily closes is 46% above trend after having fallen only 9% below trend in March of 2009. Previous bottoms were considerably further below trend.
Will the March 2009 bottom be different? Only time will tell. Meanwhile, market participation based on trend-following, such as monthly moving averages, has been an effective strategy. Note: For readers unfamiliar with the S&P Composite Index (a splice of historical data different from the S&P Composite 1500), see this article for an explanation.