I often receive emails and/or comments within individual articles asking why it is I hold a bearish opinion in spite of the U.S. equity markets haven risen dramatically since the March 6th intermediate low. Some individuals will go as far as to chastise my opinions. Let me attempt to shed some additional light on this subject, perhaps in this way you will have a better understanding of how (and why) I trade in the manner I do.

Secular Bear Markets

The very first reason I maintain a bearish outlook is that it is my view, as well as some other respected analysts, that we are in what is called a ‘secular bear market’. What separates a secular bear market from an ordinary bear market?

A secular market trend is a long-term trend that usually lasts 5 to 25 years (but whose distribution is more or less bell shaped around 17 years, in the stock market), and consists of sequential primary trends.

Even within a secular market (bull or bear) there will be secondary bullish or bearish counter trends. These counter trends typically are short in duration when measured against the primary trend before the primary secular trend is resumed.

In 1929 a secular bear market had begun and it did not end until 1944 when World War II lifted the economy out of the black hole. In between 1929 and 1944 there were a series of counter trend rallies (meaning that prices moved up against the primary secular bear trend).

Investing In Secular Bear Markets

For example, an investor like myself who recognized that we were entering into a new secular bear market in early 2008 and positioned his or her investments accordingly (short) would on this day have a gain in their portfolio of 34% today on August 7, 2009 by simply shorting the Dow Jones Industrial Average.

Compare this against investors who believed that the market would continue to go up and kept buying additional positions (long) in the Dow Industrial Average ETF (DIA) on each drop in the market (buying the dips). That individual would have a portfolio today that is at a loss of nearly 8.0% as of August 7th, 2009.

‘Buying the dips’ is what is referred to as ‘averaging down’. There are situations where averaging down can be beneficial but it is generally dangerous to do unless you are very experienced and understand the charts and know your risks and can manage them. For layman investors averaging down can be financial suicide.

Trading Within The Primary Trend

Because I hold the view that the U.S. equity markets are currently within a secular bear market then that is the primary trend. Given that this secular bear market began in late 2007 history tells me that the primary trend will last at least another 4 or 5 years at best. When an investor or trader is working within the confines of a primary secular bear market he or she has to recognize that the primary trend (down) can resume at any time. Investing or trading the counter trend rallies carry added risks because those positions are against the primary trend.

Experienced traders and/or investors can make good money trading these counter trend rallies by day trading or initiating short swing trades,  but they must never take their sights off the direction of the primary trend. Taking ones eye off the primary trend is what often leads many investors to lose even more money in the long run.

Counter Trend Rally Euphoria

Within any bear market (secular or cyclical) price movements back in the upward direction very often lead to a euphoric “all is well’ call from investors and the media. This euphoria can lead the inexperienced to make disastrous investment decisions as they solidly believe the worst is over and invest substantial sums of money in a market that has already taken away a significant amount of their money.

Euphoria in the markets has been around as long as the markets themselves. It is this constant battle between bears and bulls that gives us a market in the first place. Often is the case however with the financial media that euphoria has taken on a whole new dynamic. Case in point is CNBC, a financial media outlet that has transformed into nothing more than an entertainment outlet with cheerleaders and very biased reporting.

The advent of 24 hour financial media coverage and the Internet has create euphoric battles of the likes never witnessed in history. It is for this reason that it is even more important to remain focused on your own trading and investing strategy.

Added Complications To The Current Secular Bear Market

Secular markets come and go in cycles. A secular bear market will follow a secular bull market which was the case from 1984 to 2007. The secular bear market that now grips the markets has added issues that go beyond simple cycles. The massive amount of credit de-leveraging that is occurring at the corporate level and the consumer level is of historic proportions. The previous 10 to 15 years of the secular bull market was fueled even further by the advance of credit everywhere. Organic growth took a backseat while wild credit expansion took the wheel.

Now that all forms of credit are imploding it leaves no one to drive the car. The financial system is in shambles and the U.S. Government is desperately attempting to get credit back at the wheel, but it is damaged and won’t be able to drive much further. A return of a secular bull market will take place when organic growth is able to take hold and credit is brought back down to reasonable levels again. It is important for credit to return to acceptable levels if organic growth is to ever have a chance at taking hold.

Where Are We Now

The Government has attempted to rescue the economy by using tax payer money to rescue those corporations who became too over extended in the credit bubble. Instead of letting the system work itself out (by accepting the losses) the Government has simply given more money to institutions who became engorged in the credit bubble and not allowing that credit bubble to deflate.

Allowing the excess credit to dissolve by it’s own devices will be painful for many. More companies will go bankrupt and job losses will go even higher. But it is what is required if we are to ever return to any sustainable growth. The Federal Reserve has the essentially set the lending rate to zero, meaning that borrowing money from the Government is nearly free and allows them to in turn, via leveraging, create even more credit in a bubble full of holes. All we are doing at this time is plugging one leak after another while new ones keep forming.

Another issue with the Government bailouts is a phenomenon known as ‘pull forward’. In other words the stimulus and other programs designed to stimulate the economy are simply pulling forward any growth to the here and now in an attempt to stop the free fall of the economy. The cash for clunkers program is ‘pulling forward’ vehicle sales in an attempt to stimulate that industry. But all it accomplishes is a ‘rush of euphoria’ that all is well when companies involved in that industry talk about increased sales.

In reality all they are doing is having a massive sale (at tax payer expense) in order to pull in car buyers now. But once the sale is over it goes right back to where it was before, but next time it may be even worse because car buyers were exhausted during the ‘big sale’. And what is worse is that the Government program is actually an encouragement for more people to increase their debt loads again, when the de-leveraging process should be left to unwind without interference.

The United States has transformed into a nation of credit addicts. All the way from the Government down to the individual American. The Federal Reserve, by keeping the lending rates at near zero are simply being a drug pusher, enabling the addicts to keep getting their fix. What we have learned over the past 10 years is that whenever interest rates go up the growth of the nation is severely stifled. This is because the nation has lost its ability to sustain any form of organic growth and constantly needs that credit fix to keep going.

Until organic growth can return to the United States this secular bear market may actually last much longer than even historical norms.

Trade accordingly and be mindful of the big picture.

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