Are we there yet? Like children on a trip, investors are beginning to ask that question . . . as in, “Is the market reaching a peak? Is the next big sell-off just around the corner?” Concerns about the election, the solvency of Europe, and inflation, among others, have kept many investors on the sidelines, and yet the stock market has had a pretty good year so far. As I write this, even the month of October has avoided the usual sell-off. Is the current trend going to keep going or is this just another sucker’s rally?
To understand a secular trend, we need to go back in time to a theory developed by Charles H. Dow, the founder of the Wall Street Journal and a keen observer of the market. His observations led him to believe that primary market trends are broad movements, lasting 4-6 years. As long as each successive rally hits a higher high than the one before, we are in a bull market.
A secular bull market generally provides investors with enormous appreciation in their stock holdings and lasts for many years. A secular trend typically lasts 5-20 years and may consist of one or more primary trends in sequence. As long as each successive bull market high and each bear market low is higher than the previous one, we are in a secular bull market. The converse is a secular bear market, marked by a succession of lower lows and lower highs.
Markets don’t flip from bear to bull overnight. Steep declines, like we experienced in 2008, leave scars on investors. Typically, as a market trends toward recovery, investors are tempted to sell into the rallies rather than buy into the dips. These investors are likely to have purchased stocks at former higher levels, and are only too happy to sell and break even. This puts a lid on the market’s upside potential. This has certainly been the case as stock mutual funds have seen net liquidations continue through mid-2012. A key indicator will be whether that trend continued through the second half of the year.