Investors Weigh the Cyclical vs. the Secular

Every generation of investors tends to think of its experiences in the stock market as unique, but that is true only with respect to the names of the companies and individuals involved.

In the bigger picture, the story is always the same: recurring cycles of boom and bust, excessive optimism and excessive pessimism, money made and money lost.

The market is all about cycles, though it becomes more difficult to accept that at the extremes--when things either are very good for stocks, or very bad.

At the extremes, many otherwise intelligent people come to believe that the good times, or bad times, will never end.

That was the overwhelming sentiment in the first quarter of 2000, when the technology stock mania reached its peak.

It also may be the view of a growing number of investors today, as they confront the possibility that the U.S. market will fall for two years straight--something that hasn’t happened since 1973-74.

The blue-chip Standard & Poor’s 500 index, which slid 10.1% in 2000, is down 14.1% so far this year.

The market’s last back-to-back down years saw the S&P; plunge 17.4% in 1973 and 29.7% in 1974, amid the first oil crisis, a sharp recession, the Watergate scandal and the unwinding of the blue-chip stock mania of the early 1970s.

“Where’s the bottom?” is the universal question today, one that became a bit more desperate last week as major market indexes careened toward their two-year lows reached in April. The S&P; 500 lost 4.3% for the week to end at 1,133.58, a stone’s throw from the April 4 low of 1,103.25.

Unfortunately, simply accepting cyclicality as inevitable in markets provides no key for the door to investment riches. If cycles were the same each time in duration and magnitude, everyone would know what to do, and when.

To keep it interesting, the market makes sure to vary the lengths of cycles and the percentage gain or loss in the average stock--though investors’ overall emotional experiences are largely the same each go-round (ultimately, either euphoria or despair).

Because cycles are tough enough to call correctly (except in retrospect), long-term investors have usually been well-advised to avoid the urge to time the stock market’s cyclical swings, and instead focus on getting the secular trend right.

Wall Street’s idea of a secular trend pretty much follows the dictionary definition: “continuing for a long time, or from age to age.”

The stock market had many ups and downs in the 1950s and 1960s, but long-term performance charts of the S&P; 500 and the Dow Jones industrials make it clear that a secular bull market was going on from 1949 to 1966, fueled by the nation’s post-World War II prosperity.

After 1966, the market overall struggled until the early 1980s. A popular chart among Wall Street bears shows how the Dow index rose to just below the 1,000 mark in 1966, then spent 16 years trying to decisively break through that mark (briefly topping it in 1973, 1976 and 1981) before finally soaring through it in 1982.

There were plenty of boom and bust cycles for particular stock market sectors in that 1966-to-1982 period, but by the late 1970s many investors either despised stocks or just didn’t care about them. As inflation surged, real estate, gold, money market accounts and other non-stock alternatives became far more interesting to many people.

Was it a secular bear market between 1966 and 1982? Depending on the stocks you owned, it might have been. At a minimum it was a long period in which being out of the market may have been far more profitable than being in it, especially adjusted for inflation.

That changed in 1982, when stocks began to rocket with the economy’s rebound from the deep recession that began in 1981. Despite the crash of 1987 and the bear market of 1990 that followed Iraq’s invasion of Kuwait, many Wall Street pros argue that stocks have been in a secular bull market since 1982. And indeed, at least until 2000, it had been smarter to be in the market than out of it for the previous 18 years.

From its low in 1982 to its 2000 record high, the Dow index soared 14-fold, from 777 to 11,723. The Nasdaq composite index soared 31-fold. You couldn’t get that kind of return at the bank in that period.

For investors who are trying to keep a long-term focus today, the key issue is (or should be) whether the secular stock bull market that began in 1982 has ended or is merely facing a cyclical interruption.

If you believed that the broad market’s secular trend (say, for the next 10 years or so) would be down, or at best flat, you probably would structure your investment portfolio much differently than if you assumed the ’00 decade would repeat the ‘90s experience. Older investors, in particular, probably would favor bonds and other income-generating options over stocks, though younger people might keep loading up on equities, figuring that the 20- or 30-year payoff still should be decent.

But pinpointing the end of a secular bull market is just as tough as, or tougher than, correctly calling shorter-term market cycles. Nobody rings a bell to say, “It’s over.” All any investor can do is weigh the fundamental evidence and make an educated guess about the best portfolio composition to produce a desired return within acceptable parameters of risk.

A good starting point in assessing the stock market’s potential is to ask what factors helped spur the previous secular trend, and whether those factors are still in force.

The secular bull market that began in 1982 was powered by a host of factors, but at the top of the list are these: an expanding global economy; falling inflation and falling interest rates; rising worker productivity amid a major shift toward investment in technology; increased industry consolidation; the end of communism in Russia and the former Eastern Bloc; and favorable demographics (i.e., an aging population with larger sums to invest).

Underpinning stocks in that secular rise, of course, was a boom in corporate profits that was derived from many of the factors listed above.

Have those factors disappeared, or are they waning? The long-term-bearish case against stocks today is based on that premise. Pessimists say that interest rates aren’t likely to fall much further, that inflation is likely to turn up this decade, that global capitalism is reaching its limits (and is facing a backlash in many quarters), and that worker productivity can’t increase in the next decade as it did in the last.

Add it up, and corporate profit growth overall is destined to be slower in this decade, the bears argue. Stocks, they say, still are too highly valued for the profit growth that’s on the horizon.

The bullish case rejects all or most of those suppositions, and points to demographics as the ace in the hole: The U.S. population is getting older, and people will have to save more--and stocks still are the best savings vehicle in the very long run, the bulls note.

But as the aging Japanese population has demonstrated during that nation’s secular bear market (which began in 1990), people who become bored with stocks, or afraid of them, can find other things to do with their savings.

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Tom Petruno can be reached at tom.petruno@latimes.com. For recent columns on the Web, go to http://161.35.110.226/petruno.