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3Q17 Quarterly Investment Letter

With the end of the third quarter, my sense is that investor confidence remains low. What confidence there is seems to be fragile.

It is surprising because we are now in the ninth year of the recovery following the financial crisis.  With the jobless rate now at 4.2% it would seem we should all feel better about the future of the economy and the markets.  Unfortunately it is not the case.

Perhaps we should view this as more of an opportunity than a problem?  It might help build our confidence if we review some history for the stock market since 1926.

Since 1926 there have been eight secular bull markets. During the same period there were eight secular bears. Our data is based on S&P 500 statistics.

“A secular market trend is a long-term trend that lasts 5 to 25 years and consists of a series of primary trends. A secular bear market consists of smaller bull markets and larger bear markets; a secular bull market consists of larger bull markets and smaller bear markets.” ("Market trend - Wikipedia," n.d.)

It has been Curran’s belief that we have been in the ninth secular bull market since shortly after the financial crisis. We continue to believe we entered a “Great Bull Market” in late 2008 or early 2009.  On request, we will send you a copy of our analysis done in the 4th quarter of 2008 titled “Get Ready for a Great Bull Run”.

The most recent long-term bear began 3/24/2000 and ended 3/9/09.  We refer to it as “the lost decade” in terms of market returns.  As we all know, the stock market did not make us money during the decade of the “aughts”.  Who would have guessed aughts would describe equity returns as well as serve as an appropriate epitaph for the decade.  

Let’s take a closer look at the secular pattern demonstrated by the “Great Bear Market of the Aughts”.  The market referenced is that measured by the S&P 500.

Great Bear Market of the Aughts
Beginning       Market Peak       03/24/00       1527.46
End                Market Trough    03/09/09       676.53

Within the Great Bear Market there were actually four bears.  They can generally be described as a series of lower lows and lower highs.  So the decade began with the high of 1527.46 and after 4 bear markets (nine years later) the S&P 500 was only 676.53. 

Not only was the result disastrous in terms of its wealth destruction; another consequence was investor confidence was destroyed.  That should not be surprising and needs to be understood as a normal reaction on the part of the investing public.

Keep in mind the Great Bear Market of the Aughts followed a great bull market. From 1982 until March 2000 the S&P 500 advanced from a trough on August 12, 1982 of 102.42 to a high of 1527.46 on March 24, 2000.  The annualized return was about 17%.  The S&P 500 increased by 14 times!

Unfortunately it is not what people remember.  They remember the market was 1527 in 2000 and nine years later it was 676.  

What we should remember is: following all secular bear markets there is a secular bull market waiting to launch.  If you believe history is a precursor and not a “random walk”, then you should have confidence we are in a secular bull market.  Debatable is timing, but the facts are clear: buy equities following severe and extended periods of financial distress.

Curran believes history does repeat.  Following severe market declines, the market has always enjoyed significant advances.  The more severe crises result in longer and more significant advances.

Using data compiled by First Trust, they calculate there have been 9 secular bull markets from 1928 to include the current bull. Compared to the current bull market, four exceed this bull’s duration of 8.5 years.  The average of the longer bulls is 13.67 years.  Using the average of the longer bulls, we may have 5 more years before its demise.  The average total return was 853%.  

The current bull has enjoyed a total return of about 300%. Not surprisingly, history indicates most of the total return in secular bull markets comes in the latter years. It is what we would expect.  If it proves to be the case this time, then substantial returns will accrue to those investors who defy conventional wisdom and buy and hold stocks.

We continue to believe we are in the late early to middle years of a great bull market.

There are different ways to measure bull markets.  We have focused on both duration and total return.  We must always remember “mini bears” are natural to all secular (long-term bull markets).  The “mini bears” are followed by quick recoveries and higher highs.   Investors committed to long-term investing are well advised to welcome bear markets in long-term bull markets for one big obvious reason: it is an opportunity to buy at bargain prices.

The tough part to handle emotionally comes as a result of our most recent experiences with bear markets.  They occurred in what we now know was a secular bear market in the “aughts”.

It is normal to expect investor psychology to remain fearful of corrections and bear markets until the long term bull is taken for granted.  With each correction and bear market that is followed by higher highs, confidence will grow and the bull market will eventually be taken for granted.  When that happens we will probably be entering a speculative stage when much of the total return we expect will accrue to investors.

When that happens and we move into the latter stages of the advance, our goal to keep investors invested will turn to reducing levels of investment in equities.  The good news is we see years of advances, albeit with the inevitable corrections and declines, before we begin to seriously consider exiting the stock market.

My experience is: it is as difficult to get confident and greedy investors out of the market as it is keeping frightened investors lacking confidence in the market.

The fixed income markets today are the flip side of the equity markets.  Bonds have enjoyed a great bull market that began in the early 1980s. In our opinion, the bond market has been in the speculative last stages of their advance for the past 10 years.   If it were not for “heroic “actions by the Federal Reserve, we would have already entered a bear market.  The normal pattern for long-term fixed income markets is for secular bull markets to last about 15 years followed by secular bear markets lasting about 30% longer in years.  Clearly unprecedented aggressive actions taken by the Federal Reserve kept rates low for an abnormally long period.

The denial of risk by fixed income investors is a classic one.  Fixed income investors highly prioritize safety and income in ways similar to the way equity investors prioritize appreciation.  In spite of income wishes not being met, the sense of safety has probably never been greater or more important than it is now.  Curran believes it is forming a base for fixed income investors to experience even greater disappointment going forward than that experienced in the past nine years.  In other words, not only will rates remain relatively low but loss of principal will become an issue as rates rise.  

Bond investors have not experienced a secular trend for interest rates rising since before 1982.   Losing market value year over year in bonds is something most fixed income investors have not ever experienced.  Now they are in denial. The shock comes when bond prices decline for more than a few quarters.  Secular trends go both ways.

Our advice remains unchanged.  The outlook for equities is positive while we remain very cautious about the bond markets.  To say the least, bond investors have missed a substantial move in stocks while holding onto what could prove to be speculatively-priced long-term bonds.

To avoid risks inherent in long-term bonds, our fixed income strategy is holding primarily short-term and investment-grade fixed income securities.