The long-term history of U.S. stock prices shows there are periods, which typically last 15-20 years, that can be classified as "secular" bull and bear markets. [I don't know why secular, which normally means non-religious, is used to mean long-term in this context. On the other hand, neither or these types of animals has ever been known to practice any human religion.]

Secular bull markets, like the one in the 1982-99 period, see consistently rising stock prices and pullbacks that are much less severe than in bear markets. As important, those pullbacks or drawdowns are recovered in fairly short order. In such a market, most investors want to have their maximum level of stock ownership, and trying to identify when not to own stocks because the risks of ownership are too high, is likely to cost more in the way of investment returns than amount of drawdowns and risk avoided.

Secular bear markets, like the ones in the 1966-81 and current periods, see stock prices move in an essentially a sideways channel with some substantial declines along the way. Adjusted for inflation, the failure to make new high values results in a loss of purchasing power. The declines in prices are significantly greater than during bull markets, and take much longer, possibly many years, to recover. As 2008 illustrated in a most disturbing way, those declines and long recovery periods are the lurking danger to retirement plan investing that can substantially alter or destroy one's retirement timetable. In a secular bear market, it is well worthwhile to use tactical risk reduction models to identify when the risks of stocks (or other asset classes such as bonds) are high and the prudent action to protect one's retirement plan assets is not to own stocks.

The graph shows the Dow Jones Industrial Average adjusted for inflation and illustrates the long-term ("secular") market periods for over 100 years from the beginning of 1897 through 2011.

The vertical scale of the graph is logarithmic. With an ordinary or linear scale, it is difficult to see the variation when the prices are low. More importantly, with a logarithmic scale, equal vertical distances correspond to equal percent changes, so the relative fluctuations of the inflation adjusted Dow can be seen regardless of the actual price at the time. The severity of the 1929-32 crash is evident, and it shows that in comparison the scary "crash" on October 19, 1987, which was the largest one day percentage drop, was a relatively mild pause during a secular bull market.

It is informative to note that the peaks in the inflation adjusted Dow in 1929 and 1966 were not achieved again for about another 30 years. That is a dramatic illustration of the danger of staying in stocks during a secular bear market. (To be fair, it is important to note that the graph is based on the value of the Dow Jones Industrial Average only, so it does not include the dividends received by the owners of the component stocks, which were quite substantial at times. Had those dividends been reinvested consistently, the recovery periods would have been considerably shorter. Nonetheless, the dangers of owning stocks all the time during a secular bear market are still quite real, and dividend yields recently were at historical low levels and are still relatively low in historical terms, much less than in the 1930s, 1960s, and 1970s.)

The graph makes a strong case that we are now in a secular bear market that began in 2000. The media trumpeted the Dow making new highs starting in 2007, but as the graph shows that when inflation is taken into account, it has not yet reached highs made in 2000. (This is discussed in the third quarter 2006 Stock Market Perspective.) The three prior secular bear markets saw the purchasing power of the Dow lose a lot more than half of its value. Staying invested in stocks all the time is quite can result in a loss of half or more of your current purchasing power. Very few, if any (Bill Gates and the like are the exceptions), can stand that and still retire when and in the manner they have planned. The danger is very real, so you must take positive steps to avoid it.

The next page is the first of three that put some numbers on the behavior shown in the graph and illustrate why it is critically important to go well beyond conventional advice.

Next page: severe equity losses

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