With the first quarter of 2023 behind us, there continues to be no shortage of things to worry about. Interest rates, inflation, market volatility, continued war in Ukraine and now, as if we needed one more, a banking crisis thrown in for good measure.
“Sentiment” – the undercurrent of the market which swings continually from euphoria to deep fear – has been hanging around in the “fear” space since last year’s correction took hold.
Up until then, we had experienced a really long (more than 10 years) period of relative market stability, with incredibly low interest rates and equally low inflation. When you think about it, feeling uncomfortable and a little fearful when the opposite occurs is reasonable.
We’re only human.
It’s that human aspect that causes me to periodically step back and examine the different types of “bear” and “bull” markets (yes, there are different types) to better understand where we might be currently, AND also how to best be positioned going forward.
As you may already know, a bear market is a drop in investment prices, usually, when a market index falls by 20% or more from a high. A bull market is the opposite, marked by a market index experiencing gains of around 20% or more.
Those bear and bull periods can be long and enduring (even 18 to 20 years) as we saw in the period between 1982 and 2000. During that 18 year period, stock prices were largely on the rise. By the way, long and enduring market trends like that are known as “secular” while shorter intermittent market swings are referred to as “cyclical”.
Ready for more? From 2000 through 2008, we largely saw markets trending downward. Also a secular move, although in this case, bearish.
Finally, since April 2009, in spite of last year’s downturn, the markets have been generally trending up. A secular bull.
A special note to my religious friends; the word “secular” in this context has nothing to do with the commonly used meaning of “relating to something worldly or temporal. Rather it refers to “a long term of indefinite duration” (and yes, I had to dig deep into Webster’s list of definitions to find that!)
Think of a secular market move like the tides, which are caused by the gravitational pull of the moon and the sun, creating long-period waves that move through the ocean. They start far out in the depths, and progress towards the coastlines.
Within a secular bull or bear market, there are smaller bull and bear movements. These are “cyclical” markets, and can be likened to the individual waves within a tide. Even if the tide is up, if you are out on the water, you are still watching for the specific waves that have the ability to propel you towards shore.
Cyclical bull or bear markets are shorter time periods occurring in the markets within the context of longer term ups or downs.
What’s interesting is that those shorter term cyclical bulls and bears are still influenced by the longer term secular market that is prevailing – just like waves are influenced by tides. So if a secular trend is bullish, then a cyclical bull will tend to have a longer duration with better returns than a cyclical bull market might have within a secular (or long term) bearish trend, and vice versa.
Why is it worth understanding this bit of jargon? Allow me another minute, while I try to bring it into perspective.
Looking back at what has occurred in the markets over the past few years, we’ve seen a few significant pullbacks. In early 2020, we saw a stiff drop in market values with the shutdown of worldwide economies. In 2022, we saw market indices (depending on where you looked) dropping by the high teens, and even more if you focused solely on tech stocks.
If we use the lens of both secular and cyclical markets on the recent correction, we can see that both the size of it and the length of time associated with it are aligning more with a cyclical move.
So, am I saying that the recent bearishness has been cyclical?
Evidence is starting to pile up that this may be the case, and that we may be transitioning out of a cyclical bear back into a cyclical bull, all within the context of a longer-term secular bull market which, as we have already mentioned, has been trending since 2009.
Why do we think that might be the case?
It’s not because we have a working crystal ball (last time I checked, my crystal ball hasn’t produced anything but pretty reflections, and that’s me thinking highly of myself).
It is rather because of three factors; Inflation, Monetary Policy & Secular Markets
Inflation is, of course, a big driving force behind monetary policy AND, when monetary policy reacts to inflation, it has an impact on asset returns. We know that there are two things you shouldn’t bother trying to fight, when it comes to your portfolio: the Fed (via monetary policy) and the tape (market trends).
The Fed, like other central banks throughout the world, spent 2021 and 2022 moving from interest rates that had been flat or even decreasing in reaction to the shutdown of the global economy,into tightening mode. Nearly 90% of the world’s central banks dramatically increased interest rates during this tightening period.
Tightening periods like these have not typically been the greatest time for positive market returns. Historically, when these kinds of central bank moves occur, market returns have been, on average, negative.
So far in 2023, the tightening activities of central banks have started to scale back. The number of countries that are still in that mode over the last few months has fallen from 90% in 2022 down to around 50% currently. Why are they making that choice?
In the US, inflation seems to be cooling, from a high in 2022 of over 9% to much closer to 5% at the latest reading. The Federal Reserve is watching this, along with employment numbers which have been coming in softer and softer. They have seen monetary policy working in the way it was intended, and they don’t want to overdo it, so they’ve forecasted a potential pause in interest rate increases after May. Current trends indicate that inflation may continue to recede. This should drive monetary policy in a different direction which, in turn potentially drives asset returns in a different direction.
So, while we’re not counting on knowing the future, what we do know is how certain types of larger macro activities – like inflation and interest rates – impact the cyclical and secular markets we participate in.
At Topturn our objective is to both understand, and watch the tides, and the waves, with the ability to increase or reduce risk appropriately. With patience continuing to be one of the hallmark success factors whether you’re out on the water or investing, our understanding gives us the calm and confidence to ride even the toughest waves.
