I thought this was an interesting article. It was sent out by one of Dynamic Funds Managers. This manager oversees many of the “growth” funds within Dynamic. Nice to see a positive outlook for a change, but keep in mind “growth managers” are typically looking for reasons for the markets to rally. I hope he’s right this time!
The Echo Bear
Over the weekend in Barron’s, I read an interesting article by Liz Ann Sonders, the Chief Investment Strategist with Charles Schwab. The article is entitled “What Phase is the Stock Market in Right Now?” and it goes through a description of the four distinct phases that the market moves in and out of through a full cycle. She argues that the current cycle has been following these phases except for a hiccup this year. She postulates that barring a full US economic recession, corrective phases in this part of the cycle should be limited. The reason we are singling out this article is that it lines up very closely with our “cyclical bear” theme for 2016 that should resolve by 2017 and lead to significant equity gains once it resolves. However, their description and backtesting is more elegant and better-explained than my own so it was worth highlighting to all of you.
She cites data going back to the 1960s that the stock has operated in familiar cycles and the chart below highlights these cycles and their direction. There have been 7 cycles since 1968 that have followed these phases and the calculation of these cycles uses the bull and bear market definitions created at Ned Davis Research, a reputable research house that we have used and mentioned often in past Letters. At the bottom left of the chart, you can see that she suggests that over the last year we have transitioned from a Post-Echo Bull (from 2012) to an Echo (no recession) Bear in 2015 which we are still in. There have been 8 previous Echo Bears since 1968 with a median loss of 19% and a duration of 204 days which is very similar to what we have been calling for this year. The most recent Echo Bear before this one was from April to October 2011 where we lost 17%. The current Echo Bear started in May of last year and recent lows on February 11th brought that to a 15% decline, although the ultimate low may still be ahead of us.
I wanted to briefly describe the four phases:
These are the nasty bear markets that occur alongside an economic recession and delineate the separation point between business cycles. They typically last a median of 539 days and markets usually correct 30% from peak to trough during these periods. The most recent example of a US Recession Bear was from 2007-2009 lasting 517 days (in line with history) but with a significantly greater than average decline of 54%.
After a severe recession-fueled bear market, the market then moves into its recovery phase called the Post-Recession Bull. The median return during this phase is over 65% and it tends to last an average of 474 days. I think many of us remember the recovery phase from March of 2009 to April of 2011 that last significantly longer and bounced significantly higher, likely due to the severity of the decline that preceded it. There is only one example of the market moving from a Post-Recession Bull phase to a Recession Bear which was the double-dip recession of 1981 and we do not think the current market is at risk of such a move.
Other than 1981, the next phase of the market tends to be the Echo Bear which is a bear market that is not associated with a recession and does not typically fall more than 20% peak-to-trough. This is generally considered a pause or digestion period that sets up the market for the next phase and lines up most closely with the market we are in today. The current cycle has actually seen two Echo Bears, which occurred once before in 1987, a similar period to today that we have made comparisons to. The first Echo Bear in this cycle occurred in 2011 and the second started in May of 2015 which may have ended in February or could still be ongoing. The best description for this phase is a reset correction that allows the market to go higher as the new phase begins.
After the first Echo Bear ended in October 2011, the market went on a second extended Post-Recession Bull phase until May of last year. The duration and magnitude were significantly higher than historical medians but since May of last year, we have had two significant corrections and have re-entered the Echo Bear phase. The recent rally has not been enough to bring us back into another Post-Echo Bull phase but at some point within the next 6-9 months, we do think a new Post-Echo Bull phase will begin and run for a few years which is consistent with what we have been talking about.
Watch for the next transition from the Echo Bear to the Post-Echo Bull as that will be a very rewarding time for investors. In fact, as we have suggested, positioning over the next few months makes sense so that your portfolios are already positioned when the next Post-Echo Bull begins.
I await the signs allowing me to declare the start of the next Post-Echo Bull,