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Commentary -- January 2010

The stock market, as represented by the S&P 500 Index, hit an intra-day low of 666 on March 9, 2009 -- its second secular bear trend major low since March 2000 (the first major low was the 768 intra-day low on October 10, 2002). From the March 9, 2009 low, the market has been in a classic bull cycle. However, like many bull cycles, the bulk of the gains came in the first few months. In fact, 87% of the gains (as of 12/31/09) occurred from March 9 to September 16 while the last three months account for only 13% of the gains. This has created a rather tight trading range for the market.

You frequently hear me discuss how the stock market has historically moved in trends and cycles. I think it is now more important than ever to recognize where the market may be with respect to the current trend. Remember, trends are long periods of time where the stock market moves in one primary direction, either up or down. Up trends, also called secular bull trends, are when the stock market’s highs go higher and the lows are higher. While there are short-term pullbacks (bear cycles), the long-term direction is still upward. However, in down trends, or secular bear trends, the stock market’s highs get lower and the lows get lower. While there are short-term rallies (bull cycles), the long-term direction is still downward. 

Since 1871, there have been 11 identifiable long-term trends -- five bull trends and six bear trends. So how does one know if the market is in a secular bear trend? Since March 2000, the stock market’s highs have been lower and the lows have been lower – which is what defines a downward, secular bear trend. Now there was a brief time in October 2007 when it appeared the bear trend may have ended as the March 2000 high was briefly taken out. Unfortunately, I believe it was just a head fake as the secular bear trend came back with a vengeance and the stock market fell to new bear trend lows by March 2009. Also remember that each trend has alternating cycles. Since 1871, there has been 77 cycles -- 38 bear cycles and 39 bull cycles (this latest cycle is the 39th bull). While no one can predict the ultimate bottom of the secular bear trend with 100% certainty, we have seen at least two major bottoms so far. Will there be more? No one knows for sure. But we have to consider that possibility and actively position our model portfolios accordingly.

Statistical Evidence the Secular Bear Trend May Still be Intact

Even with the recent market recovery, the major indexes are still a long way from where they were almost ten years ago on March 24, 2000 when the S&P 500 Index closed at 1,524 and the Dow Jones Industrial Average closed at 11,112. Where those indexes were then and now verifies the current secular bear trend, in my opinion. But there are other statistics as well.

David Rosenberg, the former Merrill Lynch strategist now at Gluskin-Sheff, recently suggested the secular bear trend may be far from over when he compared data from the last secular bear trend bottom in 1982 to the same data today:

In 1982, the P/E Ratio bottomed at 6 and the dividend yield bottomed at 6%. Today, based on 2009’s estimated S&P 500 Reported Earnings of $44.50, the P/E Ratio is 25 and the dividend yield is 2%. None of the previous five historical secular bear markets since 1871 ended anywhere near today’s P/E Ratio or dividend yield.                         

• In 1982, the Federal Reserve was reducing the money supply and lowering inflation. Today, it is just the opposite as the Fed has been printing massive amounts of money in order to re-flate the economy.                                                           
• In 1982, the Federal Debt-to-GDP Ratio was 35%. Based on 2010 projections, the Federal Debt-to-GDP Ratio is estimated to be 98% --- the highest since World War II.                                                                                                 
• In 1982, de-regulation was the theme. Today, it is about re-regulation, government ownership, and too-big-to-fail.                                       
• In 1982, the dollar was beginning its own secular bull market. Today, the dollar has been mired in its own bear market as current monetary policy has been making no attempts to protect the dollar’s value.                                                   
• In 1982, income tax rates, capital gains rates, and dividend tax rates were declining. Today, I don’t believe it’s a question of if tax rates will rise – but how much they will rise.

Bottom Line: From a stock market point of view, I believe there is enough evidence to suggest, although not guarantee, that the stock market may not have bottomed. Yes,we have had a nice rally. But we have to respect history and that is why I am cautious about 2010.

Again, thanks for visiting and come back soon.

Matt Montgomery

* The Dow Jones Industrial Average and the S&P 500 Index are un-managed stock indexes. The Dow Jones Industrial Average is a registered trademark of the Dow Jones Company and the S&P 500 Index is registered trademark of the Standard & Poors Company. Investors cannot invest in the Dow Jones Industrial Average or the S&P 500 Index. Past performance is not indicative of future results.

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Matthew Montgomery is a Registered Representative of and offers securities products and services through Royal Alliance Associates Inc. Member FINRA / SIPC, a registered broker-dealer. In this regard, this communication is strictly intended for individuals residing in the states of Alabama, Arkansas, Louisiana, Ohio and Texas. No offers may be made or accepted from any resident outside the specific states referenced.

Matthew Montgomery is also separately registered investment adviser under Montgomery Financial Designs, a registered investment adviser, offering advisory services in the state of Texas. As such, these services are strictly intended for individuals residing in Texas.

Advisory services offered through Royal Alliance Associates, Inc. a Registered Investment Advisor.

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