Avoiding the Train Wreck: Addendum

We are not alone in considering the fact that now is likely the time to consider risk-managed investment strategies rather than avoid them.  One of the more cautious investors that we invest along, John Hussman, has this to say in his latest commentary today (2/18):


If there is one fatal siren’s song of investing, it is the belief that an unfinished half of the market cycle will remain unfinished. A typical, run-of-the-mill market cycle runs about 5 years in duration (though with a significant amount of individual variation). The typical bull market portion extends about 3.75 years, on average, during which time stocks advance at an annual rate of about 28%. The typical bear market portion extends about 1.25 years, on average, during which time stocks decline at an annual rate also about 28%. Historically, that puts the typical bull market gain at about 152% from trough-to-peak, followed by a bear market decline about 34% from peak-to-trough, for a cumulative full-cycle total return of about 67% (roughly 10.7% annualized). Taking the arithmetic average of past bull market declines (a slightly different calculation), the typical bear market comes in closer to a 32% decline. In any event, notice that even a run-of-the-mill bear market decline wipes out more than half of the preceding bull market advance.



To put some perspective of where the market stands at present, and why the siren’s song of the unfinished half-cycle is so dangerous here, the chart below presents the S&P 500 since 1998. Notice in particular that the apparent performance of the market is strikingly different depending on the “lookback” that investors use. The 10-year lookback and the 4-year lookback are particularly misleading because each captures an unfinished half-cycle; essentially a trough-to-peak market move. Such lookbacks are useful only on the assumption that the preceding bear market periods were entirely avoided, and that the next one will be avoided as well. Otherwise, lookbacks with less heroic assumptions (e.g. peak-to-peak across market cycles) are more reasonable.


I concur and believe that looking at returns require a 15 year look back period which includes both the 2001-2002 and the 2007-2009 declines.  As Mr. Hussman notes, we are on the 1/2 up-cycle which began in March of 2009.  While we don’t have a specific data point to estimate when the second half of the cycle might start — it clearly bears a more watchful eye.


The Hussman commentary can be found here. 


Below is the total return of the S&P 500 since 1998 for reference

Figure 1: S&P 500 ETF since 2000


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