In my last article I wrote about trading strategies you can use in a bear market. We're hearing a lot lately about being 'bearish' in these current markets, but it's worthwhile considering how you can use trends to help you with your trading decisions, even during these tough trading times.
First of all, it’s worth taking note of whether we’re in a secular versus a cyclical trend. This will make a difference because while a cyclical trend may last years, a secular trend can last decades.
Most analysts think we are in a secular bear market. That means we may see a downward trend which could take place over decades.
However, it’s not all doom and gloom. Even within this secular bear market, we are likely to see a number of cyclical bull and bear trends. And that’s where you might find opportunities in those shorter cyclical trends to make some money. You just have to know how to identify the trends.
So to recap, a secular trend is the big long trend and a cyclical trend is the shorter trend within the primary secular trend.
It’s worth looking at the history books to see how shorter trend cyclical bear markets panned out.
The biggest cyclical bear market was from 1929-32 which saw a decline of around 90% in the Dow Jones Industrial Average (DJIA).
There were also bear markets in the following periods which saw losses of around 50% for the DJIA:
1937-38
1981-82
2007-09
1973-74.
The longest bear market was 1946-49 which saw losses of around 25%.
And for the year between 1973-1974 we saw an interesting bear market. This was a time where earnings every quarter grew and yet the stock market tanked 56%.
Another interesting lesson from history was the Japanese experience in the 90s. That’s where we saw a long-term secular bear market.
From the peak of the share market in 1992 to the recent lows in 2011, we’ve seen Japan lose 80% in value in their sharemarket. While this is a sobering statistic, there has also been potential for massive gains. Here’s how…
During long-term secular bear markets, a buy and hold strategy rarely works. That’s because over that time, the market may lose 80% in value like it did in Japan in the 90s. But even in that secular bear market, there were huge cyclical bull markets. In the case of Japan for example, the biggest rally was an impressive 125% from 2003-2007.
To take advantage of the cyclical bull markets, the key is to have a method to identify these bull turning points.
A longer term moving average, like the 200 day moving average, is a useful tool for identifying turning points. This indicator only gives good signals in a trending market (where the market is moving up or down). It does not work in a non-trending market (where the market moves sideways).
You can identify a sideways or non-trending market using visual methods, that is, by looking at price peaks around the same levels and troughs around the same levels.
Alternatively, a triple moving average system can be used.
To identify a turning point using triple moving average indicators, for example, you can chart a 50 day, 100 day and a 200 day moving average.
If all three time periods show prices moving in the same direction, the market is trending. If not, then it’s not a good idea to use a trend indicator such as 200 day moving average.
But in cases like right now, where you can see a clear downward trend, then a 200 day moving average can help.
When the price line moves above the 200 day moving average line, it usually signals a buy signal. If the price line moves below the 200 day moving average line, it usually signals a sell signal.
Just remember, like other techniques including fundamental analysis, technical analysis is not an exact science, but it can be helpful to use probability to enter and exit positions.
During a secular bull market, a higher P/E ratio is expected. However, during a secular bear market, P/E ratios bottom out at depression-like levels.
The average P/E ratio of the Australian sharemarket in the last secular bull market from 1982-2011 was 15.1. The P/E ratio peaked at 22.8 in 1994.
During the last secular bear market in Australia from 1969-1982, historical P/E ratios bottomed at 5.4 in 1974. The average P/E ratio for the Australian market was 8.4 from the period 1974-1981.
So while commentators are busy saying that valuations are cheap for the market, you need to consider that yes, they may be cheap if the market was in a secular bull market. But if you think we’re in a secular bear market, then valuations are actually quite expensive.
Even for long-term fundamental investors, it becomes important to determine the type of market conditions which dominate to figure out which is the appropriate average to apply. And right now, we just have to wait and see which way the worm will turn.
Happy trading!
Julia Lee Equities Analyst
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