investment strategy, timing investments, market cycles, secular investing

Why successful investing is all about timing

15.09.2006

by Andrew Van Sickle

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Whenever markets start to wobble, investors console themselves with the thought that stocks always go up over the long term. According to the latest Barclays Capital Equity Gilt Study, UK stocks have returned an inflation-adjusted 5.2% a year over the past 106 years; in America, they have produced annual real returns of 7% over the past 80 years.

But this doesn’t mean you can just buy at any point and watch the money roll in. An investor who bought the Dow Jones index in 1929 would have had to wait until 1955 for the market to exceed its starting point. And anyone who hopped into Japan’s Nikkei 225 in mid-1986 would have had to wait until May this year for it to eclipse 16,700 again. The key is your starting point – or more precisely, the value that stocks offer at that point.

Timing your investments: secular cycles

As Bill Gross put it: “People know that if they pay twice the market price for their house, it will take years to get their money… out. Somehow, though, when it comes to stocks, they forget.” Of course, some would say that people no longer understand the true value of property either, but the point stands.

Markets move in secular (long-term) cycles from valuations above the long-term average to a point below it; the move from overvalued to undervalued is known as a secular bear market, while the opposite shift marks a long-term bull run. John Mauldin of InvestorsInsight.com says that two centuries of US market history show that secular bulls and bears last a respective average of 15 and 14 years; the shortest secular bear cycle was eight years. After the massive bull run from 1982 to 2000, which propelled the S&P 500’s p/e over 40, the trend shifted and p/es began to fall towards the long-term average of 15. History shows that the p/e ratio tends to fall below the average to single-digit levels before the next long-term upswing begins, so with the p/e currently at about 17, this down cycle has some way to run.

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Timing your investments: lessons from the past

This doesn’t necessarily presage a nasty slide; valuations can fall if the market drifts sideways and earnings gradually catch up with valuations, as was the case in the bear market of the late 1960s and 1970s. Secular bear markets are often punctuated by rising markets (known as bear market rallies), but the overall trend is down. The recovery of the past three years is in all likelihood one such rally in a long-term downtrend.

These valuation cycles are the key driver of long-term market movements; Mauldin highlights the fact that the US economy actually grew by 373% between 1964 and 1982, a secular bear phase, but only half as much in the 1982 to 2000 bull market. “The market is a lean, mean reversion machine.” At present, then, US stocks are hardly long-term bargains. Dividend yields tell a similar tale. The S&P now yields just 1.9%, having exceeded 6% in 1982; the long-run average is 3.5%. Herd-like investors neglect long-term value; indeed, “like a teetotaller at a stag weekend”, those who fret about valuations are often ridiculed in the short term, as Philip Coggan put it in his FT column. But in the long run, they will be proved right.

Long-term cycles are hardly unique to American stocks. Market historian
David Schwartz has pointed out that the stockmarket often loses money in the 15-year period following a 15-year phase of outperformance; “this has been the case in all indexes and all countries”. So UK stocks – which, while now reasonably valued at 13 times earnings, never fell to the single-digit levels that precede a long-term upswing – look likely to take a long time to shake off the hangover from the technology boom. Still, the good news is that commodities also swing up and down in secular cycles – and the last secular bear run ended just five years ago.