End of generation-long credit binge foretells long bear market

A couple of market bouncebacks in recent days can’t hide the fact that we’re in a long-term or “secular” bear market that began in 2000. This will likely continue for several more years. The fundamental force behind the current market is the ending of a generation-long credit binge. Over the last 20 years, total outstanding non-financial debt in the United States exploded from about 1.5 times GDP to 3.4 times GDP.

While the government’s effort to bail out lenders and save homeowners may make the credit contraction more orderly, the problem of too much debt can’t be fixed by shifting it to the public till.

Debt is debt. The cost of carrying it must be met or there will be more defaults.

The demise of the easy-credit cycle means that consumers, who’ve borrowed heavily to buy, will spend less. That in turn will drive business earnings down. And that should result in a contraction in the market’s price-earnings ratio, since the P/E ratio is a reflection of the investors’ confidence regarding future earnings. The probability of this “double whammy” suggests a lot more downside risk to this bear market than the risk we have been accustomed to in the past generation while credit was expanding.

What’s the bottom line for investors?

• Avoid funds that mimic broad market indexes like the S&P 500 or NASDAQ.

• Have only about a third of your portfolio in stocks, emphasizing companies with strong, global franchises and solid balance sheets, in businesses not likely to be overwhelmed by a deep, long recession.

• Emphasize cash income from interest and dividends from diverse industries.

• The remainder should go into cash, high-quality short-term bonds, a gold-bullion ETF, and inverse-index funds that rise when the stock market declines.

J. Michael Martin, CFP, is chief investment officer of Financial Advantage Inc. in Columbia, Md. He can be reached at 410-715-9200 or mmartin@financialadvantageinc.com. Financial Advantage provides personal financial planning and investment-management services to retirees and aspiring retirees on a fee-only basis.