of a Secular Bear Market
Part II: Van's
Response to a Reader
Van K. Tharp, Ph.D.
The following article is in response to an email from one of our Tharp's
Thoughts readers regarding the article Implications of a
Secular Bear Market published two weeks ago. Click here
to read the original article.
I have decided to spend some time responding to
his/her comments in case other people have misinterpreted or focused
on the wrong things in my article. I hope this helps to reiterate
what's important in my article. His/her email is in italics and my responses
are in regular type.
The opening paragraph of Tharp’s Thoughts on the Secular Bear Market is pure dribble. Your credibility is at stake writing stuff like this: “By the end of 2000, I said to everyone that we were in a secular bear market that would last
15 - 20 years. When the bull market of 2003 happened, the media announced (and many people believed) that the bear market was over and a new major bull market had begun.”
The Dow rose over 30% since your call of a 15 -
20 year secular market. Hardly a bear market!
In my opinion, the 30 Dow stocks do not represent the U.S. stock market. But since
the end of July 2000, the DOW has risen from 10511 to 13397 (with about 300 pts of that in the last two days). That’s a 30% rise, but it amounts to a compounded annual growth rate of 2.46%. And during that time the dollar has dropped
from 100.82 to 70.84. That’s a drop of 30%, so that pretty much cancels out the 30% gain.
In addition, inflation over the last 8 years in the U.S. is shown in the following chart from
www.shadowstats.com. The red line marks the start of the secular bear market. The government CPI figures, which have been manipulated since 1983, show inflation at about 3% per year. The old CPI figures show inflation averaging about 10% per year since 2000. I don’t see how anyone can be happy with a 30% gain in the DOW over the last 8 years.
As a systems educator you know that there are far too many variables at play in the markets to make such a prediction, especially such a long term one. May I suggest that you examine your own biases especially when you announce your purpose as such?
I agree with you. You don’t make money through predictions. However, I do believe that trading systems should fit your beliefs about the big picture. My beliefs say we are in a secular bear market and I post results every month in
Tharp’s Thoughts as a update. I’ve been doing that since
Safe Strategies for Financial Freedom came out just to see if I needed to say,
"Okay, I was wrong and things are different.” But even during the bull market of 2003, I didn’t see anything to change my mind, especially since the dollar went down 40% while the S&P 500 went up 30% in 2003.
My purpose in writing the article was because so many people tell us, “I don’t want to learn anything complicated because I’m just an average investor.” Well, NO ONE can afford to be an average investor in a secular bear market.
Furthermore, my definition of a secular bear market comes from the rather amazing work of both Ed Easterling and Michael Alexander. Ed’s
Unexpected Returns: Understanding the Secular Bear Market, was published in 2005, but I’d seen his work many years
earlier. Ed perfectly explains why secular bear markets occur and why they have nothing to do with the economy. I don’t want to get into his logic
here because this is to be a short article, but I suggest you read his book. Ed also showed great curves predicting what the market might do over the next 10 years beginning in 2000 on his web site,
www.crestmontresearch.com. Furthermore, Ed has published, for many years, great charts showing returns over many years on his website – just to show that during secular bear markets you cannot buy and hold.
Michael Alexander’s book was actually published in 2000
in which he also predicted the beginning of a huge bear market. His book,
Stock Cycles: Why Stocks Won’t Beat Money Markets Over the next 20 Years, is also excellent reading.
Lastly, I’ve written 3-4 articles on the secular bear market in
Tharp’s Thoughts over the years. The secular bear market is one of valuations, not prices. Now in an inflationary bear market (which is what we are in), we could see the dollar deflate to a value of 10 cents while the DOW goes up to 50,000. So the dollar loses 90% while the Dow goes up 4 times. A terrible trade off, but
that's what you might get in a secular bear market.
Such bear markets last until PE ratios go to single digits and that’s a long way away for the S&P 500 from where it is now. It could easily drop another 50% or more. The drop in valuations that happen during a secular bear market is one reason I’ve stopped using the 1-2-3 model that we presented in
Safe Strategies. PE ratios have declined to the point where that model will start to turn bullish. However, I don’t expect the secular bear to stop until the PE ratios get into the single digits like they did in 1982 and 1949 – the end of the prior secular bear market.
Taking a 10 year period as you have in the quoted paragraph below and ignoring what has happened in between is spin doctoring to suit your current marketing bias. C’mon, get real. And get objective, just like a systems trader should be.
“On July 20, 1998 the S&P 500 stood at 1140.80. Ten years later on July 16, 2008 the S&P 500 stands at 1245.36. That amounts to a 10-year gain of 104.56 points or 9.1% in ten years. That’s a compounded annual growth rate of 0.88%. That’s what I’d expect from a secular bear market, and it could get much worse.”
Okay, since the secular bear market started in 2000, the real return on the S&P 500 has been a minus 13% or a CAGR of minus 1.2%. I thought I was being rather
fair by including the last two years of the secular bull market. The buy and hold people usually quote the returns over a ten year period and that’s what I was doing.
But remember my purpose in the article was to respond to the many people who say, “I’m just an average investor. I don’t want to do anything complicated.” My purpose was to say that you cannot afford to be an average investor. YOU CANNOT AFFORD TO BUY AND HOLD IN THIS TYPE OF MARKET.
And then continuing in your article quoting the media…... As a trading systems educator you are supposed to teach objectivity through using a system that emanates from the market and here you are joining the “noise” brigade.
I don’t know how many people on our database consider themselves to be average investors
as opposed to professional traders, but it’s probably quite a few. The media is basically controlled by its advertising and they want you to think
You should buy and hold to make money.
You cannot time the market.
Making money is all about picking stocks.
If something goes wrong, you picked the wrong stock.
Warren Buffett holds on through 50% drops because then things really are a bargain, then you should do so as well.
Now that the market is down, it’s especially attractive and you should buy all you can
and just hold it.
As I said in the article, this is very, very dangerous for the average person. It’s pretty much like trying to build a bridge or managing a computing system or operating on someone
all without any training. You could NOT do those things in your respective occupations – instead, you get many years of training. But you can do that in the market. And the result is financial suicide. Only day trading systems and swing systems are working in today’s environment, so position traders should probably be 100% cash – although that position might change next month and I’d say that in my monthly update.
So what are you trying to accomplish? ( I added this question just to complete this
article because I want to reiterate what was important in my
previous article rather than emphasize my opinion about the state of the market which is what the reader was reacting to.)
I actually thought that the article on the secular bear market was one of the more important articles I’ve written. And part of the reason for that was my message to people. The comments pretty much ignored that message.
Let me repeat that I think people who develop systems need to be aware of the big picture. They need to develop systems that fit the big picture. And they need to be ready with other systems when the big picture changes.
These were the important points in that article:
Trading is 100% psychology so you must master
everything is psychology, so that’s why I can make that
statement. You can
only trade your beliefs (which are psychological filters to
reality). Even the
act of executing a trade involves the mental strategy of 1)
seeing the signal; 2) recognizing that this is the
signal you should take; 3) feeling good about it; and then 4)
Given that everything is psychological, success
in the markets is 60% discipline, 30% position sizing, and 10%
system. You can have
a great system that will be destroyed by mistakes created by a
lack of discipline.
You should never enter into a position without
having a worst case exit, which I call 1R (R stands for risk).
You also need profit taking exits.
The bottom line is that you should always be looking at
cutting your losses short (making them 1R or less) and letting
your profits run (making them much bigger than 1R).
You need to develop a business plan that
includes (but there is a lot more) the big picture, at least
three non-correlated (totally different concepts) systems, and a
worst case contingency plan.
Your system must fit your beliefs about the
market or you will not be able to trade it properly.
You need to know how your system will perform
in various types of markets.
And my definition of market type (based upon the S&P
500) is published monthly in Tharp’s
you have a market type in which your system does not perform
well, you shouldn’t be trading a system that works in that
type of market.
90% of performance variability is due to position sizingSM and few people understand that concept.
If you don’t know yourself, then you cannot
determine what you really want from the markets.
Your system has nothing to do with meeting your
objectives. You meet
your objectives through position sizingSM.
Few people understand this, even those who understand the
impact of position sizingSM.
You can make money under these conditions, and you
can do so without doing a lot of work (perhaps trading a few hours a day). For example, we have systems that I would define as Holy Grail systems. Some of them are even fairly long term, but you must know when to apply them. And most of you, right now, would make so many mistakes trading them that you would destroy them – at least until you have done the necessary preparation work.
Furthermore, let me repeat. You meet your objectives through position sizingSM. A Holy Grail trading system would only make it easy to do.
But to get to the point where you can do that
easily requires some work. And please don’t use the excuse, “I’m just an average investor!” Did you start in your regular profession without any training, saying “I’m just an average doctor or engineer or IT professional?” No, you didn’t. You prepared yourself. What most of you are doing as “average investors,” trading in today’s market conditions without adequate preparation, is equivalent to operating on someone’s brain without any training or building a bridge without any training! If you did so, the person you were operating on would probably die and the bridge would probably collapse. Investing in today’s secular bear market without thoroughly understanding all of the above principles means that your financial nest egg will probably die. Many of you did that in 2000-2002. Please don’t keep doing it.
Van Tharp: Trading coach, and author, Dr. Van K. Tharp is widely
recognized for his best-selling book Trade Your Way to Financial
Freedom and his outstanding Peak Performance Home Study program
- a highly regarded classic that is suitable for all levels of
traders and investors. You can learn more about Van Tharp at www.iitm.com.