Book Reviews, Trading

Book Review of Investing in the Second Lost Decade by Pring, Turner, Kopas

The full title is Investing in the Second Lost Decade: A Survival Guide for Keeping Your Profits Up When the Market is Down by Martin J. Pring, Joe D. Turner, and Tom J. Kopas.

The book has an associated website here: which contains updated information from the authors. The authors are also principals and portfolio managers at Pring Turner Capital Group, a money management firm that applies the business cycle investment strategy.

This is a pretty interesting book, in that it links together the stock, bond, and commodity markets. The discussion on secular stock market cycles is in the same vein as what Ed Easterling’s books go into. I would recommend people to read Ed Easterling’s books first before tackling this one because Ed’s books will give a better appreciation of secular cycles.

This book goes into an important area that Ed did not, which is the timing of it all. When do you buy/sell? How do you detect that the cycle has turned? The authors used a combination of moving averages, trendlines, and oscillators to achieve that. While the book highlighted that their barometers are proprietary, the book did give some suggested indicators that should be helpful in getting people most of the way there.

One particular thing that I liked is the discussion of business cycles within secular cycles, including indicators for helping to detect changes in the business cycles. This information helps improve timing decisions for other markets especially bonds and commodities, since most people have always been focused on stocks.

The book had a chart (Chart 3-3) which compared the current secular bear with the average U.S. experience since 1900. The experience since 2000 has followed the average secular bear experience very nicely so far. Based on the chart, we should see the U.S. stock market decline until the end of 2012, hold steady/decline slightly more until the end of 2013, before a recovery starts to bring it to a high at around 2015. This does not bode well for the coming months/year and we will have to see how that plays out. At least for now, the trend is in the stock market is clearly downwards.

Two Types of Cycles – Business Cycle and Secular Cycles

  • Business cycles
    • Normally triggered by inventory adjustments, and lasts from trough to trough (or peak to peak) of around 4 to 5 years.
    • Examples of cyclical industries are home building, auto industry, heavy manufacturing.
  • Secular cycles
    • Due to structural problems, e.g. excessive debt, railroads in 1870s, manufacturing in 1929, electronics in 1960s, dot-com in 1999, housing in 2007.
    • These average around 30 to 40 years from trough to trough. Post-1900, inflation-adjusted secular bear markets have lasted around 18 to 20 years.
  • Secular trends dominate the characteristics of cyclical trends
    • During a rising secular trend, bullish cyclical trends are persistent and have substantial magnitude, cyclical bear trends are short and shallow.
    • During a secular bear market, cyclical bull markets tend to be shorter and limited in scope, and cyclical bear markets tend to be far more severe.
  • To build wealth in a secular bear market, take advantage of business cycle swings.

Two Key Factors That Cause Secular Trends

  • Psychology: Swings from extreme (irrational optimism) to extreme (unjustified pessimism) in investor sentiment leading to extremes in valuation (i.e. P/E ratio)
    • Shiller P/E of 22.5 and above reflects overoptimism, and 7.5 and below reflects excessive despondency.
  • Commodity prices: Trend of rising commodity prices leads to the demise of equities (inflation adjusted prices, i.e. real)
    • The CRB Spot Raw Industrials index (U.S. based) is used to reflect commodities not influenced by weather or speculative trading.
    • Data from 1850-2012 showed that a sustained trend of falling or stable commodity prices is positive for equities, as all secular bulls developed under such an environment. 1929-1932 was an exception due to unstable commodity prices.
    • Note that there can be business cycle-associated commodity price declines along the way (e.g. in 2008) where both commodity prices and stock prices are moving down.
    • To identify secular peaks in commodity prices (which corresponds to a secular low in equities), calculate a price oscillator using a 24-month (2-year) simple moving average divided by a 240-month (20-year) average, to look for peaks and troughs in the oscillator.

Secular Trends in Stocks, Commodities and U.S. Government Bond Yields

  • Stocks
    • Post-1900, inflation-adjusted secular bear markets have lasted around 18 to 20 years.
    • Secular bear markets in the past: 1901-1920, 1929-1949, 1966-1982, 2000-current. The past secular bear markets averaged between 4 and 6 recessions.
    • Secular bull markets show much less stock volatility compared to secular bear markets.
      • The 1949-1966 secular bull market had no occurrences of a 25% inflation-adjusted market decline. The 1982-2000 secular bull had only one such decline during the 1987 crash which was relatively short.
      • The past 3 secular bear markets had 5-7 price swings in excess of 25% (3 recessions = 5 swings).
    • Based on the average of past secular bear markets
      • Inflation-adjusted stock prices starts high, the current secular market started at year 2000
      • Drops to a -45 to -50% level in 2-3 years (1st recession)
      • Recovers to a -15% to -20% level by the end of year 7
      • Drops back down to the -60% at year 8.5 (2nd recession)
      • Recovers to a -25% level at year 10.5
      • Drops down to a -45% level at year 13 (3rd recession)
      • Recovers to a -35% to -40% level at year 15
      • Finally drops down to a -65% to -70% at year 20 (4th recession).
  • Commodities
    • From 1840-2011, the average secular bull market for commodities lasted 19 years (past 4 were 22, 23, 19, 12 years), and the average secular bear market for commodities lasted 22 years (past 4 were 33, 13, 18, 22 years).
    • Since the inception of the Federal Reserve, there has been no secular downtrend in commodity prices (the Fed acts to prevent falling prices to prevent deflation), hence the secular bear in commodities are actually multi-year trading ranges
  • U.S. Government Bond Yields
    • From 1870-2012, bear markets for bond prices (bull for yields) averaged 30 years (past 2 were 21 and 40 years), and bull markets for bond prices (bear for yields) averaged 25 years (past 2 were 29, 21 years, current one is running at 31 years).
    • U.S. bond yields have been in a secular downtrend (bull market for bond prices) since 1981, or about 31 years at 2012, hence a potential turning point can be close.
    • Nonetheless, yields often experience extended trading ranges at secular lows prior to the uptrend getting under way. E.g. 1886-1906 and 1939-1951.
    • Markets reach their peak popularity at their highest point. In 2012, PIMCO Total Return Fund (bond fund) is the largest mutual fund in the world,  while Fidelity Magellan Fund (stock fund) was the largest in 2000.

How Inflation, Commodity Prices, P/E Ratios, and Bond Prices are Linked

  • Inflation corresponds with rising commodity prices, which cut into corporate profits, lowers P/E ratios, and discourage investments in bonds as interest rates move higher.
  • Commodity lead bond yields at secular lows. When commodity prices rise, bond market participants anticipate that inflation is going to intensify, and they start selling bonds, which pushes up yields.
  • Rising commodity prices is inflationary on the one hand, but when they suck out some of the purchasing power from consumers, they have a deflationary effect.

Rapidly Moving Commodity Prices in Either Direction are Bearish for Stocks

  • Calculate a Commodities Price Oscillator (1/18) that measures how each monthly level in the commodity index deviates from its 18-month MA (e.g. CCI).
  • If you plot that and line it up with the inflation-adjusted S&P500 index, it will show that unusually large swings in commodity prices adversely affect equities as they are associated with the worst equity bear markets.
  • Sharp commodity momentum rallies that develop from an extremely oversold condition are bullish for equities because they signify a recovery coming out of a deep recession.

Using the Movements of Commodities and Stocks to Identify Negative Stock Environments During the Business Cycle

  • Condition #1: Declining commodities prices are dangerous when both stocks and commodities have negative momentum.
    • It shows that the economy is weak and downside commodity instability is sufficient to have an adverse effect on stocks.
    • This condition is true when the 9-month ROC for inflation-adjusted equities and commodities are both below zero.
  • Condition #2: Increasing commodities prices are dangerous when stocks fail to respond
    • You would expect commodities with gradual positive momentum to imply a growing economy which would reflect in rising stock prices.
    • However If commodities accelerate to the upside and stocks factor in these inflationary pressures in a negative way, the market is expecting these end-of-cycle pressures to soon end in an economic contraction.
    • Subtract a specified ROC for inflation adjusted equities from that of commodities (i.e. take the difference between the two ROCs). This condition is true when the difference exceeds a triggering level.
  • Condition #3: Equities itself is not doing well
    • This condition is true when Inflation-adjusted equities is below its 9-month MA
  • When either Condition #1 or Condition #2 is true, and Condition #3 is true, then equities are risky and should be avoided.
  • When only Condition #3 is true, it is a sufficient condition and equities should be avoided.
  • It is all-clear to invest in equities when Condition #3 is false, and neither Condition #1 nor Condition #2 is true.

Identifying Reversals in Secular Trends

  • Stock Market
    • Stock/Commodity Ratio
      • Calculate a Stock/Commodity Ratio (S/C Ratio), such that when stocks outperform commodities the ratio moves higher.
      • Calculate the 96-month (8-year) moving average of the S/C Ratio. When the S/C Ratio crosses above its 96-month moving average, it typically signals a major equity bull market. A cross down below the 96-month moving average usually happens in a secular bear market.
    • P/E ratio
      • Shiller P/E of 22.5 and above reflects overoptimism, and 7.5 and below reflects excessive despondency.
    • Dividend yield
      • At the bottom, dividend yield of the S&P500 may approach around 6%.
      • At the top, it may be 2-3%.
    • Tobin’s Q (total market value of the stock market / replacement cost of all underlying companies)
      • At the bottom, ranges between 0.3 to 0.4 (ending Tobin’s Q for last 4 secular bears were 0.36, 0.33, 0.30, and 0.82 as of 2012).
      • At the top, ranges between 1 to 1.8 (starting Tobin’s Q for last 4 secular bears were 1.24, 1.26, 1.06, 1.82).
    • Money supply
      • Calculate the ratio between S&P500 and the money supply (M2)
      • Termination of secular bear markets has been signaled in a timely and reliably fashion from a combination of the ratio crossing above its 96-month MA, and a violation of the then prevailing secular down trendline (on the ratio, not the S&P500).
  • Commodities
    • Create an oscillator for the CRB Spot Raw Materials index, dividing a 360-month (30-year) moving average by a 60-month (5-year) moving average.
    • Secular momentum buy and sell signals are triggered when the oscillator crosses above and below its 48-month (4-year) moving average.
  • Bonds
    • Plot a 240-month Rate of Change (ROC) indicator on the U.S. Government 30-year Constant Maturity (TYX) to identify long-term swings.
    • First part of signal is when the trend line on the 240-month ROC indicator has been penetrated.
    • Second part of signal is when the trend line of the U.S. Government bond yield has been penetrated (at early-2012, the trendline level to penetrate above is 4.4%).
    • Third part: Plot the 9-month exponential moving average (EMA) and the 96-month (8-year) EMA of the bond yields. It is bearish when the 9-month EMA is below the 96-month EMA, and vice versa.
  • Inflation
    • When commodities are outperforming bonds, it indicates inflation. When bonds are outperforming commodities, it indicates deflation.
    • Calculate a Commodity/Bonds Ratio (C/B Ratio). Look for a trendline violation to signal secular trend reversal.
    • Construct a 60-month moving average/360-month moving average of the C/B Ratio (i.e. a 60/360 price oscillator). [my note: it is not specified but it seems that same as for commodities, a 48-month moving average of the price oscillator is used as the signal trigger line]

Business Cycle Sequence

  1. Money Supply >> Bond Prices >> Stock Prices >> Economy >> Commodities >> Money Supply
  2. Economy is in a recession. Fed injects liquidity into the banking system, increases money supply, lowers interest rates, and raises bond prices.
  3. After a lag, common stock prices bottom as investors make purchases ahead of the actual turn in the economy.
  4. Economy strengthens due to increased money supply, lower interest rates, and renewed stock market optimism.
  5. Commodity prices strengthen due to increased demand and in most cases a slightly tighter supply situation.
  6. This eventually leads to unacceptably high price inflation, leading the Fed to tighten money supply.
  7. Demand for credit in the form of bank loans pick up as borrowers wants to capture low interest rates while they are still available. The tightening of supply and increased demand for credit raises interest rates and lowers bond prices.
  8. Rising interest rates lead to an economic slowdown or contraction, however corporate profits are still growing as rates rise so stocks are still going up. However as rates rise even higher, stock investors sell off anticipating the economic downturn.
  9. As the economy slows, demand for raw materials decline and commodity prices peak and start to head lower.
  10. Fed stimulates the economy again when there are unemployment concerns with a contracting economy.

Six Business Cycle Stages

  • Key notes
    • The 6 stages take place over a period of 4 to 5 years.
    • Stages 1-3 represent economic contraction and recovery. Stages 4-6 represent economic expansion and back to normalcy.
    • The 6 stages move sequentially approximately 85% of the time. Stages 7 and 8 occur about 10% of the time, when the asset classes get out of sequence. Sometimes the cycle will skip a stage or two, or even retrograde to a previous stage.
    • Use the historical sector performers as a guide but always confirm sector leadership by analyzing the trend of the sector’s relative strength (using moving averages, trendlines, and oscillators).
  • Stage 1
    • Bonds bottom, buy bonds
    • Bonds: Bullish
    • Stocks: Bearish
      • Best performing sectors: Home builders, restaurants, utilities
      • Worst performing sectors: Diversified metals, industrials, communication equipment
    • Commodities: Bearish
  • Stage 2
    • Stocks bottom, buy stocks
    • Bonds: Bullish
    • Stocks: Bullish
      • Best performing sectors: Brokers, automobiles, semiconductors
      • Worst performing sectors: Copper/gold, oil drillers, energy
    • Commodities: Bearish
  • Stage 3
    • Commodities bottom, buy inflation sensitive assets
    • Bonds: Bullish
    • Stocks: Bullish
      • Best performing sectors: Communication equipment, diversified metals, energy
      • Worst performing sectors: Leisure, airlines, home furnishing
    • Commodities: Bullish
  • Stage 4
    • Bonds peak, sell bonds
    • Bonds: Bearish
    • Stocks: Bullish
      • Best performing sectors: Oil drillers, computer hardware, gold shares
      • Worst performing sectors: Hotels, brokers, home building
    • Commodities: Bullish
  • Stage 5
    • Stocks peak, sell stocks
    • Bonds: Bearish
    • Stocks: Bearish
      • Best performing sectors: Health care, diversified chemicals, consumer staples
      • Worst performing sectors: General merchandising, automobiles, semiconductors
    • Commodities: Bullish
  • Stage 6
    • Commodities peak, sell inflation sensitive assets
    • Bonds: Bearish
    • Stocks: Bearish
      • Best performing sectors: Household products, life insurance, food products
      • Worst performing sectors: Chemicals, railroads, steel companies
    • Commodities: Bearish
  • Stage 7 (out of sequence)
    • Bonds: Bearish
    • Stocks: Bullish
    • Commodities: Bearish
  • Stage 8 (out of sequence)
    • Bonds: Bullish
    • Stocks: Bearish
    • Commodities: Bullish

How to Identify Business Cycle Stages

  • General: 12-month moving average
    • A market that is above its 12-month moving average is treated as bullish, and a market below its 12-month moving average is bearish.
    • A stage is identified by classifying each of bonds, stocks, and commodities as bullish / bearish, and referencing the stage table above. Hence when bond prices are bullish, and stocks and commodities are bearish, it is Stage 1.
    • A 12-month moving average is used because it includes every month in the calendar year and hence is seasonally adjusted.
    • To prevent whipsaws, use only month-end levels to calculate the moving average.
  • Specific for stocks: S&P500 / M2 Money Supply
    • Most business cycle associated bottoms during secular bear markets occur when the 24-month Rate of Change (ROC) on the S&P500 / M2 Money Supply ratio drops down and reversed around or below the -30 level.
  • Specific for commodities: 18-month ROC on M2 velocity
    • Plot the 18-month ROC on the velocity of M2 (i.e. GDP/M2).
    • When the velocity is low, the new money is parked and not used for production, hence prices remain subdued. When velocity is high, and production does not rise proportionately, prices will.
    • The ROC oscillator series lines up with the peaks and troughs of the CRB Spot Raw Industrials index (i.e. both peaks and troughs at the same time).

Asset Allocation Should Be Based on Cycles, Not Age and Risk Temperament

  • Asset levels should be actively changed based on the historical risk/reward relationship of each asset around the normal cyclical swings in the economy and the financial markets.

Identifying Intermediate Moves

  • Within the 4-5 year cycles, there are intermediate market moves that last from 2 to 6 months, which can take prices up or down by at least 10% (compared with 25% business cycle moves with a secular trend).
  • To identify intermediate moves, analyse the following
    • Monetary conditions – Fed’s policy actions, discount rate, margin requirements, bank reserve requirements
    • Market trend – advancing vs. declining stocks, new highs vs. new los, up to down volume, overbought or oversold
    • Investor sentiment

Top-Down Portfolio Management Process

  1. Understand the secular environment for stocks, bonds, and commodities.
  2. Identify the business cycle stage and change allocations accordingly.
  3. Identify the intermediate trend based on monetary conditions, market trend, and investor sentiment.
  4. Select high-quality stocks with rising dividend stream.

Leading, Coincident, and Lagging Economic Indicators

  • Leading: Housing starts
  • Coincident: Nonfarm payrolls, GDP
  • Lagging: Unemployment

Inflation Hedges (i.e. Inflation Sensitive Assets)

  • International bonds denominated in a currency of a leading natural resource-based country (e.g. Canada, Australia)
  • Energy, metals, mining, agricultural, and forest products companies.
  • Natural resource ETNs specializing in specific commodities, sectors, or commodity indexes.
  • Resource-based investment trusts in U.S. and Canada.

Current (early-2012) Situation

  • Bonds
    • U.S. bond yields have been in a secular downtrend (bull market for bond prices) since 1981, or about 31 years at 2012, hence a potential turning point can be close.
  • Commodities
    • As of early early 2012, the secular uptrend for commodities which started in 2002 remains intact. The commodity secular bull market is expected to last until 2016-2022.
    • What is causing commodities to rise
      • Strong demand from emerging markets of Brazil, India, and China, and also other growth markets in Asia, Latin America, Africa, Eastern Europe, and the Middle East.
      • The last commodities boom in the 1970s led to ample supplies and net shrinkage in new mining, exploration, and farming projects worldwide. Hence new raw material supplies is not sufficient to meet demand.
      • The printing of money by central banks lowers the value of currencies which translate into higher prices for commodities.
  • Stocks: Secular downtrend in prices remains intact.

International Markets

  • Inflation-adjusted MSCI World Stock ETF (deflated by a global CPI from OECD) is in line with the inflation-adjusted S&P composite.
  • Inflation-adjusted German DAX is in line with the MSCI World Index since 2000.
  • Inflation-adjusted Nikkei shows a secular bear starting from 1989, with a 82% decline in line with the U.S. in terms of duration and magnitude. There are 9 swings of more than 25% since 1989. Real Japanese stock prices is comparable to real U.S. stock prices lagged by 126 months since the U.S. secular bear started in 2000.
  • Shanghai Index peaked in 2007 with a 18-month ROC of 327. That likely signified the peak of a secular cycle.
  • Italian market using the inflation-adjusted BCI Commerciale showed that a secular bear started in 1966, secular bull started in 1977, and another secular bear started in 2000.
  • Inflation-adjusted Bombay 200 remains in a long-term secular bull which started in 1975. If the 2009 low is taken out, that may signify the movement into a secular bear market.
  • Two structural factors appear to influence secular trends
    • Good population pyramid (i.e. large base and thin top) augers well for India, Brazil and South Africa.
    • Lower government net debt as a percentage of GDP augers well for Indonesia, South Africa, India, and Brazil.

Tips on Technical Analysis

  • Momentum series
    • Any momentum series assumes in its calculation that prices are undergoing a cycle of a specific length.
    • If that cycle diverges significantly from that time span, reversals in such velocity measures are likely to be unduly late or, on occasion, premature.
    • Signals (e.g. smoothed momentum series reverses direction) must be confirmed by a reaction in the actual price (e.g. trendline break, moving average violation).
  • Trendlines
    • The more times a line has been touched or approached, the better it is as a reflector of the underlying trend.
    • The longer the line, the bigger the trend being monitored and the more significant the eventual penetration.
  • Analyzing time series
    • Trends in any time series can be appraised using a combination of moving averages, trendlines, and oscillators.


  • CRB Spot Raw Industrial Index data:
  • Dow Jones Pring Business Cycle Index (DJPRING)
  • Pring Turner Dow Jones Business Cycle ETF (DBIZ)
  • iShares Barclays 7-10 year Bond Fund ETF (IEF) – For Stage 1
  • iShares Barclays 20-year Trust ETF (TLT) – For Stage 1
  • iShares iBoxx $ High Yield Corporate Bond Fund (HYG) – For Stage 2
  • Dow Jones-UBS commodity Index (DJP)
  • Martin Pring’s The All-Season Investor
  • Martin Pring’s The Investor’s Guide to Active Asset Allocation
  • Martin Pring’s Technical Analysis Explained



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