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On the surface this seems simple to understand. The Dow goes up, it's a 'bull market', the Dow goes down it's a 'bear market'. But, in reality, bull and bear markets are far more complex. Let's assume we have just five asset classes. Real estate, stocks, bonds, cash, and gold (or a hard currency for which money supply growth is kept at the rate of real GDP growth leading to stable prices).
At present, it is clear that the Fed is printing money. So, all asset prices except bonds will rise in value. But, some asset prices will increase more than others. Since October 2002, the Dow Jones has rallied in US dollar terms, but against gold it has depreciated.
So, we can say that, yes, the Dow has been in a bull market since October 2002 in dollar terms, but it has been in a bear market in gold terms. This is an important point to understand. In case we should experience continuous monetary inflation, which could lift, over time, all asset prices such as stocks, real estate, and commodities, some asset classes will increase more in value than others.
This means that some asset classes while rising in value could deflate against other asset classes, such as happened with the Dow against gold since year 2000. I have pointed out in earlier reports that since 2002, all asset prices rose in value. But recently, some diverging performances emerged. Bonds started to decline and seem to be on the verge of a significant long term break down.
Bonds worst investment
I have also mentioned in earlier reports that, in times of monetary and credit inflation, such as we have now in the US, bonds are the worst possible long term investment. Another asset class, which has recently begun to depreciate against gold are home prices.
Since last summer, home prices while only declining moderately in dollar terms, have declined significantly in terms of gold. So, whereas it took over 500 ounces of gold to buy a typical house in the US last summer, now, it only takes around 380 ounces of gold. In other words, home prices have declined over the last 9 months by 25% against the price of gold!
What I really want every reader to understand is that bull and bear markets are extremely complex and an asset class, which seems to be in a bull market may not necessary be in a bull market when compared to a hard currency such as gold. In this respect the following is also important to consider. Conventional wisdom has it that a true market bottom, which offers a once-in-a-lifetime buying opportunities, only occurs after a devastating bear market.
In this context, the following severe market declines usually spring to investors' minds: the 1929-1932 bear market in US equities; the collapse in the US bond market between 1970 and 1981, when yields on 30-year US Treasuries rose from 6% in 1970 to 15.84% in September 1981 and sent bond prices tumbling; the 1973-1974 Hong Kong stock bear market, which brought the Hang Seng Index down by 90% to its December 1974 low at 150; the great sugar bear market, which sent prices down from 70 cents per pound in 1973 to 2.5 cents in 1985; or the Japanese bear market post-1989, when the Nikkei dropped from 39,000 to less than 8,000 in April 2003.
Moreover, major market lows are associated by investors with total despair and panic among market participants, depression in the asset class that was subjected to the bear market, bankruptcies in that sector, and overwhelming negative sentiment.
Bear anatomy
But, as Russell Napier shows in his recently published book Anatomy of the Bear — Learning from Wall Street's Four Great Bottoms the key element in undervaluation can also be a period of time 'when the advance in stock prices has failed to keep pace with the economic and earnings growth' within the system (The book - an excellent read - is available from Amazon.com or from CLSA directly).
Napier shows, for instance, that at the market low in 1921 the Dow Jones Industrial Average was no higher than it had been in 1899 — 22 years earlier — while nominal GDP had increased by 383% and real GDP by 88%! Similarly, by August 1982, the Dow Jones Industrial Average was no higher than it had been in April 1964, and was down by 70% in real or inflation-adjusted terms.
Dr Marc Faber
