Déjà Vu, All Over Again?

Relentlessly rising oil prices. Inflationary pressures building. Slow economic growth. And a stock market stuck in neutral. To veteran investors, it's starting to feel like the 1970s again.

More precisely, if the recent articles we've seen are any guide, it's becoming popular to compare the current market situation to that of 1966-1982.

This isn't a totally original idea. Several prominent market watchers were quoted in the late 1990s and early 2000s as saying they expected a sustained period of relatively flat stock market returns. Given the tremendous gains of the 1982-1999 period, they figured it was unlikely the stock market would be able to mount any serious further advances for quite a while.

It's easy to understand how someone would come to that conclusion. Consider the chart linked below.

It's a bit different than most stock market charts because it's a "logarithmic" chart. That means the vertical proportions of the chart stay the same each time the market doubles. In other words, the vertical distance between Dow 100 and 200 is the same as the distance between Dow 5,000 and 10,000.

This gives us a clearer view of the true path of the market over the past 88 years. As an investor, the effect on your wealth is the same any time the market doubles, regardless of how many Dow points are involved. But that fact is easily lost in most charts where the huge number of points gained since 1982 tends to obscure all of the market's movements prior to that point.

The chart shows that over the last century, the market moved through several distinct bull, bear, and sideways periods, and that each was quite prolonged at times.

The most dramatic bull markets are easily spotted (1921-29, 1950-66, and 1982-2000) as are the major bear markets which began in 1929 and 2000 (1973-74 isn't quite as obvious).

But in between the prolonged market advances are uncomfortably long periods during which the stock market just flattened out. That's not to say there weren't significant gains and losses within those "flat" periods. The 1966-1982 period, for example, contained four separate bull markets with each gaining 32%-75%, as well as five bear markets with losses of 24%-45% each. But at the end of all this activity, 16 years went by with the Dow ending at the same level it started.

These "secular bear markets," as they're sometimes called, are a scary proposition for investors to consider. They call into question the validity of buy-and-hold investing, and really do a number on the idea of passively investing in index funds.

But consider them you must. With the appearance of the 2000-2008 version, these long, flat periods are as vivid a part of the historical record as the bull markets connecting them.

Thankfully, accepting the existence of these secular bear markets isn't necessarily the same thing as worrying about them. Two key questions should dictate your attitude towards these market plateaus.

1. How long is your investing time frame? A 40-year-old investor should react differently to the prospect of a decade or more of flat market returns than a 60-year-old investor. The retiree or near-retiree would view this as a more threatening event due to their shorter investing time horizon. The younger worker, on the other hand, should ideally view a flat market as a tremendous opportunity to load up on shares at reasonable prices.

Upon closer examination, a flat market of several years may not be as dire a threat as it first appears, even for investors about to retire. These days a realistic retirement time frame usually extends at least 20 years into the future, maybe more. That's long enough to work through an extended flat market and still derive some benefit at the other end. Those already in retirement when such periods arrive are more at risk, though they've likely had the benefit of a long bull market during their peak earning years. Most importantly, as we'll see next, there are still ways to prosper even if the market indexes flatline for a decade or more.

2. Are you indexing or Upgrading? This is the key to the whole discussion. It's clear that a strategy tied to the movements of the broad market will be unsuccessful if the broad market is stagnant for an extended period of time.

The legion of investors who piled into index funds during the 1990s bull market, and who have dutifully stayed there over the past decade at the advice of the financial services industry, have been sorely disappointed.

Cruelly, the market offers just enough rallies to sustain one's optimism. But an index fund can only mirror the performance of its underlying index, meaning all indexers — including, to a slightly lesser extent, those following SMI's Just-the-Basics strategy — have seen their portfolios do little more than tread water for the past nine years (see the table in Second Quarter Review: Prelude to A Bear Market listing the historical performance of SMI portfolios). Sadly, that's also the best they can expect from the future until the sideways period ends.

The scenario is much brighter for Upgraders. While the market as a whole may be zigging, there are always parts of the market that are zagging. The market is fickle, and changes its affections for companies of different sizes and styles regularly.

The 1970s, which many seem to be worried we're about to repeat, present a good illustration of this. The decade began with all attention focused on the "Nifty 50" — a strong advance by the market's largest stocks. By the latter part of the decade, the situation had completely reversed, with these same darlings completely out of favor and a strong rally in small company stocks underway. Yet the Dow started and ended the decade in basically the same place, completely masking these powerful undercurrents. Upgrading is designed to exploit these shifts within the markets, capitalizing on each new trend as it emerges.

We've seen these dynamics at work over the past nine years. While the market path has included both sharp gains and losses, the net effect has been that the market leaders have barely budged.

On July 2, 1999 the Dow Jones Industrial Average closed at 11,139. On July 9, 2008 it closed at 11,147. It moved plenty during those nine years, but here we are at nearly the identical spot.

(In fairness, broader market indexes have done a bit better. The Wilshire 5000, which SMI uses due to its being the broadest measure of the U.S. market, was up 19.2% over the nine years ended June 30. Still, that's only 2% annualized, not even enough to keep up with inflation.)

Yet despite the broad market failing to gain much ground over the past nine years, Upgrading gained an incredible 153% during that same period, deftly taking advantage of the currents beneath the market's surface. That's an annualized gain of 10.8%!

Clearly Upgraders have much less to fear from "secular bear markets" or market plateaus than those whose investment returns are tied to the market indexes. In fact, it's pretty easy to argue Upgraders don't have anything to fear from these sustained plateaus at all.

Circling back to the original question of whether the current market will repeat the 1966-1982 experience, the honest answer is nobody really knows. If so, it would seem that we're likely closer to the middle of the plateau period than the beginning, given that the last two sustained secular bear markets lasted 13 and 16 years respectively, and we're already at least eight years into this one.

Let's assume for a moment that we are merely half way through a sustained period of flat market returns. Two conclusions are evident based on our discussion so far.

First, Upgraders have little to fear, as the strategy has shown itself capable of harvesting significant gains during periods when the broad market indexes are not advancing.

And second, look once again at the chart of the Dow linked to earlier in this article. Imagine you're an investor in 1944 or 1974, but you have the ability to see the rest of the chart. So you know that after 6-8 more years of relatively flat action the market will begin a long bull market advance. Would you be frightened, or elated?

You'd be excited, wouldn't you? In fact, wouldn't you want to accumulate as many shares as you possibly could during those next few years — when prices would remain relatively steady — in anticipation of the huge bull market to come? Given we're at least eight years into the current plateau, that seems like an appropriate reaction to our current situation.

Today's market may seem more threatening than exciting. But if you can lift your gaze beyond the gloom of the present to consider the potential of the next phase of the market's cycle, it's an incredible perspective-shifter.

Instead of questioning whether you should stay invested or sell, you'll likely start looking for opportunities to add to the number of shares you own, knowing your actions now will likely pay off in a big way whenever that next sustained bull market arrives.

Mark Biller is Sound Mind Investing's Executive Editor. His writings on a broad range of financial topics have been featured in a variety of national print and electronic media, and he has appeared as a financial commentator for various national and local radio programs. Mark is also the Senior Portfolio Manager of the SMI Funds.

• Lost Decade? Not for SMI Investors
• Would You Like to Buy Low, Sell High? Your First Step Is to Buy Low.
• How to Virtually Eliminate the Risk of Capital Loss

• Got a question or comment about this article? Discuss it on our Message Boards.