Where is the stock market headed?

June 1, 2008
With so many dentists approaching retirement age, the investment climate in the next 10 years has never seemed more critical and yet at the same time more uncertain.

For more on this topic, go to www.dentaleconomics.com and search using the following key words: New Economy, Michael Alexander, Bull and Bear stock markets, K-Wave Cycle.

With so many dentists approaching retirement age, the investment climate in the next 10 years has never seemed more critical and yet at the same time more uncertain. Where does one look for guidance during these times? Wall Street and the Fed seem lost in solving the problems created by the debt bubble and appear complicit in creating the problem. Academics seem to only embrace mathematical models that adhere to strict statistical probabilities while ignoring the frequent large improbable outcomes that seem to mock statistical tools.

While modern portfolio theory has provided important mathematical insight into portfolio construction, at times its adherents act like farmers who insist on “diversification” of planting times. By planting corn every month of the year, the farmer can be assured of finding one period of time when conditions are ideal. Fortunately, yields are great enough from one successful planting to provide for failure in 11 of the 12 months. All one needs is an infinite supply of seed. Unfortunately, dentist-retirees typically don't have the luxury of an infinite supply of retirement capital.

Being a voracious reader, I constantly look for investment books that provide clarity and guidance. Books that can provide this clarity in the investment arena are rare; however, I have found two that I recommend. Both books are written by Michael A. Alexander, PhD., a research engineer in the pharmaceutical industry.

In early 2000, Alexander wrote “Stock Cycles: Why Stocks Won't Beat Money Markets Over the Next Twenty Years.” To appreciate the audacity of his forecast, one need only remember the investment psychology of early 2000 and the promises of the New Economy and a forever bullish stock market. For the decade-to-date (Dec. 31, 1999 to early 2008), the S&P 500 Index lost 9% and the NASDAQ lost 44% of their relative values. In this decade, money market funds have outperformed stocks in line with Alexander's forecast.

While anyone, occasionally, can get lucky with a forecast, Alexander's next book, “Investing in a Secular Bear Market” (written in early 2003 when the S&P 500 Index dropped to 800 points), predicted the Index should “return to the neighborhood of its old highs before this current expansion is over.” The S&P 500 had peaked in 2000 at 1,500, then dropped to 772 in October 2002 at the time of Alexander's second book. Since then, it increased to 1,500 again in fall 2007, precisely in the neighborhood of the 2000 year highs. The conclusions to Alexander's second book had the dry tone of a research scientist: “Future readers can then assess the accuracy of the predictions to directly assess the utility of the historical methods described here.”

What Alexander believes to be dominant in economic and stock market outcomes is the existence of a Stock Cycle. On the average, this is an 18-year period that is either dominantly upward (Bull Stock Cycle from 1982 to 2000) or dominantly downward (Bear Stock Cycle from 1966 to 1982). Four Stock Cycles of 18 years each comprise a K-Wave Cycle of 72 years. Each K-Wave Stock Cycle component has characteristics. The four K-Wave Stock Cycles are K-Wave Winter, Spring, Summer, and Fall. Alexander states that the last full K-Wave Cycle consisted of Winter: 1929 to 1949; Spring: 1949 to 1966; Summer: 1966 to 1982; and Fall: 1982 to 2000. Each cycle was an alternating Bear, then Bull Stock Cycle between 16 to 20 years.

According to Alexander, the average 18-year secular Bull cycle has a 13.2% per annum real investment return, while the average 18-year secular Bear cycle has only a 0.3% per annum real investment return. The author forecasts that we are entering K-Wave Winter cycle, a secular Bear market that should last from 2000 to 2018.

You should not infer from the Stock Cycle methodology that a strategy for successful retirement is simply to own stocks during Bull cycles and cash or bonds during Bear cycles. Unfortunately, no forecasting methodology, however accurate in the past, can make life quite so simple. These two books advocate that a buy-and-hold methodology works well in a Bull Stock Cycle and a more tactical approach is needed during a Bear Stock Cycle. While Alexander presents some simplistic investment tools, the focus of his books is not on sophisticated investment strategies.

There is no flawless forecasting method, nor is forecasting long-term economic outcomes necessarily a prescription for success; however, an investor may benefit from a knowledge of the investment seasons and planning for the favorable and unfavorable winds that accompany them. Alexander's books present a new type of calendar for investors, an investing Farmer's Almanac, without the astrology.

Brian Hufford, CPA, CFP®, is CEO of Hufford Financial Advisors, LLC, an independent, fee-only planning firm that helps dentists achieve financial peace of mind. Contact Hufford at (888) 470-3064, or at [email protected].

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