Finding Opportunities in a Bear Market

Take heart: Stocks don't go straight down year after year. Mini-bull markets can emerge in the gloom. At least for a while

It has been a rotten time to be an investor. But Ned Davis Research, a financial research firm in Venice, Fla., has some good news: In times like these, during a decidedly bear market, one often gets big upswings. NDR's chief investment strategist, Tim Hayes, looked at the four secular bear markets since 1900 (as he measures them, they came in 1906-21, 1929-42, 1966-82, and 2000 to the present) and has defined 18 cyclical bull markets that took shape within them. (The defining characteristic of a secular bear market is that it starts with a bubble and ends with no one interested in stocks, Hayes says, and they typically last more than 10 years; a cyclical bull market is shorter and may occur within either a secular bull market or a secular bear.) The median upswing was 371 days, and the median rise of the Dow Jones industrial average was 55%.

BusinessWeek's Amy Feldman spoke with Hayes about secular bear markets, cyclical bull markets, and what these patterns mean for investors.

Are we headed for a lost decade?I wouldn't say we're heading into one—we've been in this environment since 2000. Since January 2000 the annualized return of the Dow was -4%, and after inflation it was -7%. We don't think we're at the end of this secular bear market, but that doesn't mean there isn't a good cyclical opportunity.

What has happened in secular bear markets in the past?These things go on for many years. The last went from 1966 until 1982. Some people compare today with the 1930s, a time characterized by deflation and the stock market crash. Now is closer to the 1970s in terms of market action, but there are differences in the secular trends. While commodities today have had a big decline, they have maintained their long-term uptrend. We've called that a cyclical bear market in a secular bull market.

When will the secular bear market end?Secular trends typically end when valuations go to an extreme. You start to have a price-earnings ratio so low—typically single digits—that it cannot get lower at the same time that earnings are actually growing relatively well. When people have given up on stocks, you have reached the end of the secular trend. Our measures say we are about halfway down from the bubble of 2000. If you date this secular bear market from the beginning of the decade, you still have five years to go, maybe longer. It could end up being more like the second half of the 1970s, when the real damage was done in the first half of the secular trend and then you go through a long consolidation, or recovery, period.

With markets falling around the world, is there any reason to invest globally anymore?We've seen correlations [between the U.S. and international markets] tighten up, as they tend to do at the end of a decline. But there will be longer-term opportunities in emerging markets and China, where the long-term case remains favorable. China is not in a secular bear market. It has been in a cyclical bear market within a secular bull market. While markets around the world will move in one direction when we get the next move higher, the upside will be much greater in the markets in secular uptrend, like China's.

Where's the upside at home?You could get a cyclical bull market, where valuations expand for a period of time. The median cyclical bull within a secular bear is a rise of 55%. There have been 18 cases of this. So we are pretty hopeful about the next six to nine months.