So-called “bear markets” refer to stock markets that drop at least 20 percent, so conventional wisdom would hold that we currently don’t have to worry about one. The economy is showing steady gains, and the current administration promises that this is just the start of something big. The Institute of Trend Research, with a long history of being generally correct at predicting future market cycles, offers an encouraging overview as reflected by its leading indicator. This shows the U.S. economy’s year-end industrial production rising 2.2 percent over the same previous one-year period. Exports are up more than 6 percent compared with the previous year, and we know that an expanding world economy has contributed to our own record profits. All of the above is expected to accelerate at least into mid-2018. Conventional wisdom has picked up on these signals and has expanded them indefinitely into the future — or so it may appear.
Well, conventional wisdom often proves to be wrong — and these days, “conventional wisdom” is shaped by what we hear from financial pundits. Jim Cramer, the guy who yells a lot on TV, in 2007 was famous for saying that Bear Stearns was in terrific financial shape and a good buy — the day before the firm collapsed. Lawrence Kudlow, our new White House economic adviser has a long string of similar “crow-eating” pronouncements — all enumerated in a recent New York Times article. So what’s the real connection between the stock market and the economy?
As the late economist Paul Samuelson famously remarked, “the stock market has predicted nine out of the last five recessions.” What this illustrates is a stock market that can get it wrong both coming and going. A rising market doesn’t necessarily mean a robust economy and a robust economy doesn’t guarantee a bullet-proof market. So what’s an investor to do?
First, it can pay to study more market history. Mark Hulbert of the excellent, time-tested Hulbert Financial Digest lays it out effectively in a recent column as he chronicles the connection between markets and recessions going back to 1900. Citing work by Ned Davis Research, he points out that of the 22 recessions over about 120 years, 20 of them were preceded by bear markets which occurred, on average, about eight months before the economic deluge. So, if we wait for the economy to start blinking its low-confidence-indicator light, we will be too late to dial up a more conservative investment allocation. Speaking of confidence, the widely vaunted “consumer confidence indicator” has never accurately predicted anything except a change in the pricing of used boats (according to the aforementioned ITR.)
The Baltic Dry index measures the amount of commodities being shipped. Common sense would tell us that more raw materials shipping would lead to more production and more sales sooner rather than later. Then, there is the relatively new CBOE (Chicago Board Options Exchange) volatility measurement known as the “VIX” which charts what is termed the “fear index.” This is quantifying the original Wall Street axiom: “the market climbs a wall of worry.”
Rather than being obsessed with predictions of future economic outcomes, it’s more constructive to know ourselves and what personal circumstances allow us to take risks — and if so, how much. Knowing that, it’s reassuring to remember that, over time, a 50/50 mix of stocks and bonds (in inexpensive mutual funds) have proven to generate long-term results of about 7 percent per year. A 30/70 mix of bonds/stocks has been about 9 percent, and all stocks widely diversified — about 10 percent.
For what it may be worth, that 50/50 mix has created comparatively few loss years since 1970, and the losses have been minimal — generally less than 5 percent. Beyond this simple economic history, there’s no further magic. Ironically, the boredom of a simple strategy is often the enemy of investment success. It’s like the cartoon whereby the Labrador retriever is staring glumly into the crystal ball as the fortune teller says, “I see a retractable leash in your future.” Boring for him, of course, but he won’t get run over by a truck.