Staying on the good side of the bear

The downturn could bring an extended flat stock market like the one from 1966 to 1982, making it even more important to diversify

By By Tom Petruno
Los Angeles Times
July 06, 2008 6:00 AM

Small investors constantly are advised to think long-term and to avoid panicking over short-term stock market declines.

But what if the long-term picture for the market was no better than the short-term picture?

The latest slump in share prices is renewing a polemic that has flared off and on since 2000: Would the great bull market of the 1980s and 1990s be followed by a generally dismal period for U.S. stocks that might also go on for decades?

It's painful for many people, particularly baby boomers, to think about this, given the nest eggs they've built up in stocks. The fact is, there are ways to protect your portfolio, but you can't escape risk whether you're in the market or out. (More on this later.)

In Wall Street parlance, a very long period of falling or, at best, sideways-moving stock prices is termed a "secular" bear market. And there have been some doozies in relatively recent U.S. history.

From 1966 to 1982, for example, the Dow industrial average made no net progress. There were some huge rallies and steep declines — typical bull and bear markets — along the way. But a buy-and-hold investor in that 16-year period had no price appreciation to show for it by August 1982.

Many people who had relied on the market for retirement savings in that era wound up with far less of a nest egg than they had expected.

No wonder by 1982 most Americans had sworn off stocks — unfortunately, just as the market finally was climbing out of its *censored*.

In the '80s and '90s, of course, rebounding U.S. prosperity was mirrored by a spectacular surge in stocks that reached its zenith with the dot-com insanity of the late-1990s.

But with the crushing decline in share prices in 2000-02, a secular bear market had begun, some Wall Street pros believe. They say the market's steep drop since October, with the Dow now off nearly 20 percent, is just another phase of the secular downtrend.

"I think we've probably been in a secular bear market since the summer of 2000," said Bruce Bittles, veteran strategist at investment firm Robert W. Baird & Co. in Nashville.

The first phase, he said, was the crash in overvalued tech stocks and many blue-chip names. Now, the risk is that the credit crunch stemming from the housing market's plunge will be a drag on U.S. economic growth for years to come — in turn, severely slowing profit growth for many companies and sapping investors' enthusiasm for stocks. Earnings, after all, underpin share prices.

What's more, the stock market faces a major headwind it didn't face in the '90s: Record prices for oil and other commodities are driving inflation higher. That means low interest rates probably have nowhere to go but up, something the Federal Reserve signaled again this week.

Rising interest rates can be crippling for stocks because they raise companies' borrowing costs and make bonds more alluring as investments, at stocks' expense.

Against this backdrop, "earning real returns in the stock market is going to be very difficult," said Michael Pento, market strategist at Delta Global Advisors in Huntington Beach, Calif. And not just for the next year, but perhaps well into the next decade, he said.

The secular-bear crowd already has the trend on their side, at least in terms of the performance of blue-chip stocks: With the decade nearly over, both the Dow and the Standard & Poor's 500 are below their levels on Dec. 31, 1999.

Although investors in blue-chip stocks have earned cash dividends along the way, those payouts have been relatively meager. Through May, the S&P 500 index's return to investors in this decade was an average of just 1.1 percent a year including dividends.

But that's a misleading number for most investors, and here's why: If you're saving regularly via a 401(k) retirement plan, you were buying into the market when it was high in 2000 — but also when it was down in 2001 and 2002. Measured from the end of 2002 the S&P 500 is up 45 percent, despite the 18.3 percent drop since October.

There's another issue here that nervous investors have to keep in mind: The stock market is a big place. Even though blue-chip issues have done poorly in this decade, it has been a good time to own small-company stocks. The Russell 2,000 small-stock index, for example, has gained 6.2 percent a year since 1999 with dividends.

Foreign stocks, meanwhile, have performed far better than the U.S. market since 2002, and many Americans have eagerly diversified abroad, which has helped their overall returns.

What if a secular bear market in stocks is underway worldwide? It's a risk, certainly. But if you forsake stocks entirely at this point and shift your assets to cash, you're taking on another form of risk: If the gloom is overdone, and stocks do OK over the next five years, you could be leaving a lot of money on the table. Cash accounts, after all, aren't paying much.

Short of abandoning stocks, there are other steps you can take to potentially help buttress your portfolio. One is simply to increase the level of diversification. Pento advises focusing on commodity-related investments and specialized funds that track foreign currencies, on the assumption that a weak U.S. economy will mean a continuing drop in the dollar.

Ultimately, time is the stock market investor's ally. The longer you can wait, the greater the odds that the market will produce healthy returns for you, short of Armageddon.

But if "long-term investing" to you means five years, you have to allow for the possibility that the market may not cooperate — and worse, that it could ravage your nest egg. Cash and short-term bonds don't pay much as an alternative these days, but if you're going to need your money sooner than later, the stock market may be offering even less peace of mind than usual.


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