Sunday Musings: The Last Down Leg

Last Sunday, I talked about “Looking Ahead To The Next Crash.” Today, let’s look at some highlights from “The Last Down Leg:”

My market outlook hasn’t changed much since 2000: we’re in a secular bear market.

I know, the market made a new high in 2007. It made a new high in 1973 as well, then fell off a cliff until it reached bottom at the end of 1974.

If you look at all the secular bear markets on a chart, they all look pretty much the same; three down legs interspersed by two profitable counter-trend rallies. October 2002 to November 2007 was a very profitable counter-trend rally; the rally off the March 2009 lows has been pretty spectacular as well.

The thing is, you have to have that last down leg to finish out the cycle.

We were probably on our way last summer until Federal Reserve chief “Big Ben” Bernanke pulled the QE2 rabbit out of his hat. The elections added some fuel to the fire, as did the extension of current tax policy and the haircut in FICA withholdings. Rising oil prices will negate any potential stimulus from the extension of tax rates, and the reduction in FICA will come to a halt at the end of the year.

QE2 will come to an end in June and the bond market will go nuts if there is any talk about a QE3. State and local governments will be submitting budgets in June and July and those aren’t looking real good right now. So between the end of qualitative easing, rising oil prices, and the drag from state and local governments, those are pretty strong headwinds for a fragile recovery to survive without further stimulus.

I have been talking about a correction since early January, and then I think we’ll have one more rally before it’s all said and done. This time when they roll out the fat lady, I think she will sing until we find out if the March 2009 lows were the lows of this bear market.

With the above as a backdrop, I am pretty defensive. I own a lot of oil, which I bought in October 2008. Even back then I thought we would make a run at the old highs of $150 per barrel. Today that pretty much looks like a layup. If you aren’t long energy I think you’ll get another chance to buy, however. I have a suspicion we’ll see a technical rally in the dollar that will knock oil prices down a tad.

However it plays out, the bear will breathe its last at the end of 2012. This will be the greatest buying opportunity for a long time. Most folks will miss it though. Bob Farrell had a list of rules and I think No. 9 was “the public buys too little at the bottom and too much at the top.” The public wouldn’t touch the market in March 2009; now they can’t get enough of it. Check out the outflows from bond funds and emerging markets into U.S. equities the last two months and you’ll see what I mean.

So play defense and stick to high-quality blue chips with long dividend histories and records of consistently increasing dividends. They may go down as well but they’ll recover first and the dividends will provide income; something tells me that’s something we’re all going to need.

If the author thinks that we might be revisiting the March 2009 lows, why on earth would you want to have any exposure to equities, even blue chips with dividends?

If there was anything to be learned from the past two bear markets, it’s the fact that no prisoners were taken. The better choice in my view is to step aside when the trend change to the downside occurs and reload your portfolio gun once upward momentum has been restored.

I agree with most observations above, especially that Bernanke interfered with market direction via QE2 in September 2010, which affected a deteriorating trend that reversed during the last quarter and pushed the major indexes into positive territory YTD.

It makes me wonder what the markets would be like had there not been any interference from various stimulus attempts. Maybe we will find out later this year once QE2 expires.

Two areas that I like in this environment from a fundamental and technical point of view are Energy and Commodities. Both are in strong up trends and, given the current political unrest in the Middle East/North Africa, along with continued population growth, their future prospects look bright at this point.

Check the current StatSheet for more details regarding no load funds/ETFs that cover those sectors.

About Ulli Niemann

Ulli Niemann is the publisher of "The ETF Bully" and is a Registered Investment Advisor. Learn more
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