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Our view on global investment markets:

April 2012 – “1982”

Keith Dicker, CFA

Chief Investment Officer

[email protected]

www.IceCapAssetManagement.com

mailto:[email protected]

http://www.icecapassetmanagement.com/

http://www.icecapassetmanagement.com/




2

Jump!

2www.IceCapAssetManagement.com

1982 was the best year ever. The crazy disco craze was finally over.

Spielberg’s E.T. was hitting the big screens and Van Halen was just 2

years away from learning how to jump.

Yet, the biggest reason for celebration was the end of 16 tortuous

years of stock market losses. Since 1966, investors in the stock

market had lost -10% of their money. Imagine that, a -10% loss from

the stock market over 16 years.

Well, at least these 1970 era investors were not invested during the

1937-41 market. These unfortunate souls lost -38% of their hard

earned savings over a 5 year period.

Better yet, the only good news for these pre-war investors was that

they managed to avoid the 1929-32 market when the luckiest

investors only lost -80% of their money.

These 3 prolonged stock market slumps are forever known as Secular

BEAR Markets. And to be fair, and balanced, the stock market has

also banged out 4 equally opposite periods where investors made

boat loads of money during Secular BULL Markets.

Unknown to many, and ignored by the rest, we are right in the middle

of another long and dragged out Secular Bear Market which has

seen investors lose -7% since the year 2000. That’s 12 years of high

hopes for nothing.

April 2012 1982

Like every industry, the investment business loves to throw around its

own jargon. For better, or worse the money business seems quite

fond of Bulls and Bears. Bulls or Bullish means prices are rising,whereas Bears or Bearish means prices are falling.

Chart 1 on the next page provides a great picture of the stock market

from 1900 to 2012 with every Secular BULL and BEAR Market shown.

You’ll quickly notice that investors make a lot of money during

Secular BULL Markets, while losing a lot of money or perhaps still –

not making any money during Secular BEAR Markets.

Understanding secular markets and how they transition from BULL

to BEAR is perhaps the most rewarding investment perspective you

won’t hear from anyone else. While financial markets continue to

yo-yo with our retirements, the truth is, the next Secular BULL

Market is not quite ready to perk its head up just yet.

Day Traders are Passé

Thanks to our enjoyable age of instant communication, one can be

easily forgiven for monitoring financial markets every minute of theday. In fact it has become so bad that day-traders are now viewed as

long-term investors. Sad, yet true.

Years ago when most current investment professionals entered the

industry, the 3 to 5 year business “cycle” was talked about now and

then. Since this period seemed like an eternity, one could easily be




Chart 1: Secular Markets 1900 to 2012

April 2012 1982

2%

317%

-80%

200%

-38%

774%

-10%

1214%

-7%-100%

100%

300%

500%

700%

900%

1100%

1300%

1901 to 1920 1921 to 1928 1929 to 1932 1933 to 1936 1937 to 1941 1942 to 1965 1966 to 1981 1982 to 1999 2000 to ???

Practically everyone in the World remembers

the 1982 to 1999 Secular BULL Market and

they extrapolate this experience as the one

that should continue indefinitely.

Source: data from www.CrestmontResearch.com, DJIA and S&P 500 Index, graph by IceCap Asset Management Limited

http://www.crestmontresearch.com/

http://www.crestmontresearch.com/



4

Ziggin’ and Zaggin’


forgiven for having glazed eyes when “secular” markets were

discussed.

Secular markets are usually even longer than the typical 3-5 year

business cycle. In fact, the longest Secular Bear Market was 16 years in

the making from 1966 to 1981. While the longest Secular Bull Market

clocked in at 24 glorious years from 1942 to 1965.

The key point with secular markets is that overall, the stock market

moves in one general direction during a long time period. Now, within

this long-term period, we undoubtedly experience shorter time

periods where the stock market will zig and zag in spectacular fashion.However, looking through this emotional and financial roller coaster,

the end result is always the same – a higher market during a Secular

BULL Market and a lower market during a Secular BEAR Market.

Chart 2 on page 5 shows the 1966 to 1981 Secular Bear Market. You’ll

first notice that over this 16 year period, the buy and hold investor lost

-10% of their money. That’s not a happy time.

Yet, within this 16 year period there were 4 mini-periods that gaveinvestors >+30% returns. Alas, every time investors felt the good old

days were back again, the market produced another 4 mini-periods

that gave investors losses of -25% and more each time.

The lesson – unless you are a skilled and nimble trader, beware the

Secular BEAR Market.

Think long-term

When I first started in the investment business, I was told very clearly

that stocks never lose money over the long-run. Long-term investorsare always rewarded for their patience – if they just hung in there they

would never lose money. Considering this sage advice was proclaimed

in the 1990s, hindsight makes it easy to see how Secular BULL Market

fever had gripped the industry.

Unfortunately today, most investors and investment professionals

have ever only experienced the Secular BULL Market of 1982 to 1999.

Those were fun times for sure – after all, everyone made money.

As they say – you always leave a party when the party is going good.

Well, the stock market good stopped going just as the millennium

kicked in. Unknown to many at the time, the newest Secular BEAR

Market had started and continues today into the year 2012.

What causes a Secular Market

There are 3 key drivers of stock market returns – profits, dividends and

Price-to-Earnings Ratios (PE Ratio). While profits and dividends are

important, nothing moves the stock market more than the PE ratio.

We ask that you stay with us as we offer our explanation of a PE ratio.

In the magical World of investments, the PE ratio is simply the price of

a stock divided by the amount of earnings per share for the company.

As an example, if IBM is trading at $200 and is making $13 per share in

earnings, its PE ratio is $200/$13 = 15x.

April 2012 1982




-10%total return

over 16 years

Chart 2: Secular BEAR Market from the 1966 to 1981

April 2012 1982

Copyright 2012, www.CrestmontResearch.com



6

The magic # is 10


April 2012 1982

eventually end, so do Secular BULL Markets. Years later when this end

arrives, the PE ratio peaks which sets the stage for the beginning of a

Secular BEAR Market. The table below details every SECULAR marketand notes the PE ratio at the beginning and end of each one.

Secular BEAR Markets are notable for the long and gradual decline of

the PE ratio which drags stocks lower and lower, until the PE ratio once

again hits 10x or less.

In the year 2000, the stock market’s PE ratio was 42x. Today, the PE

ratio sits at 23x and remains quite a way off from the level necessary

to launch another booming period to make lots of money.

If this sounds pretty simple, it’s because it is. All we need to know now

is what causes this PE ratio to change.

As a comparison, Apple trading at $620 with earnings of $35 per share

has a PE ratio = 18x.

This means investors are willing to pay $15 for every $1 of profit from

IBM, while they are willing to pay $18 for every $1 of profit from

Apple. All else being equal – Apple’s higher PE ratio means investors

will pay more for $1 of profit from Apple compared to $1 of profit

from IBM.

As we rise above the trees of individual stocks and look at the forest,

you’ll be delighted to know that there is also a PE ratio for the entire

stock market. Based upon the calculation method developed by Yale’sRobert Shiller’s, today’s PE ratio for US stocks is = 23x.

The most important point to remember about PE ratios is that in

general the stock market is considered cheaper when the PE ratio is

low versus high. With a PE ratio today = 23x, cheap isn’t exactly the

best word to use when describing the stock market.

Next we will share with you something your current advisor is likely

reading themselves for the very first time - how the PE ratio makes andbreaks Secular Markets.

The Beginning of the End

Every Secular BULL Market begins with a PE ratio of 10x or lower. Then

as the life of the Secular BULL Market grows, the PE ratio begins to

climb, propelling the stock market higher and higher. As all good things




7

Price Stability


April 2012 1982

The Change

While many analysts, economists and strategists will tell you a million

things that will cause the PE ratio to change, there is no denying thatthe #1 change agent is inflation.

Inflation measures the change in prices of all the stuff we buy. The

stock market is a good place to be when the change in prices is pretty

stable at about 1% per year. We like to refer to this as price stability.

Chart 3 on page 8 shows what happens to the PE ratio in relation to

changes in inflation. What you’ll see is that the real fun for the stock

market begins when inflation begins to move back towards 1%.Regardless if inflation is 8% or 0%, when it begins to move back to

1%, PE ratios begin to rise which in turn sling shots the stock market

along with it.

Now the opposite also happens. When inflation is close to 1% and

begins to move away from this level, PE ratios begin the dreaded

decline from high to low.

Today, reported inflation is pretty close to the price stability level of 1%. It’s quite obvious to anyone who is following the global debt crisis

that the central banks of America, Japan, Britain and the Euro-zone are

all printing money. In general if you print money, super charged

inflation is sure to follow.

At the same time, we are also experiencing a collapse of property

markets in America, Japan, Britain and the Euro-zone. The bursting of

these property markets is hugely deflationary.

Regardless, if investors believe inflation will skyrocket or plummet it is

very unlikely that inflation will remain at the 1% or price stability level.

And, since PE ratios always decline whenever inflation moves away

from price stability – the stock market will remain in this Secular BEAR

Market. Expecting the stock market to continue to zoom higher while

the PE ratio is declining is the same as trying to swim while wearing

concrete boots.

As a result, we ask when will the Secular BEAR Market end?

The answer is pretty easy actually, the market needs to reach a PE

ratio of about 10x or less. Now back in 2009, the market was well on

its way to naturally achieving this. However, once the money printing

machines kicked in and various governments refused to let the big

banks collapse, the market was unable to reach its natural state of

equilibrium.

Since the central banks and governments cannot indefinitely delay this

adjustment, we return to our question – at what level will the stock

market return to a PE = 10x.

For the stock market to reach this valuation level, only 2 scenarios




High Inflation from money printing will

result in a very low PE ratio

Deflation from bursting of global property

bubble will result in a very low PE ratio


Chart 3: How PE ratios are affected by inflation

April 2012 1982



9

Careful where you park your car


exist: 1) the stock market would have to decline by about 50% from

current levels, or 2) the stock market will stay flat while we wait for

earnings to double from current levels, which could take 7 to 10 years.

While this analysis is quite likely unbearable for the investment

departments at the big banks, we take comfort in knowing that once

the market does recalibrate at a PE ratio = 10X, the next Secular BULL

Market will begin. And, everyone who has their wealth in tact at this

point will make a bucket load of money as the good old days return.

Obviously, the trick is to ensure you have your wealth in tact when this

day comes. IceCap is very comfortable with our long-term view andare managing client portfolios accordingly.

We are equally sure the big box banks have also adopted similar

strategies for their clients and this will undoubtedly allow everyone to

stay rich and become richer at this key turning point in the future.

Good days lie ahead for us all.

Public Gatherings in Protestation

First we had thousands occupying Syntagma Square in Athens. A fewmolotov cocktails and overturned cars later, the Greeks certainly made

their point of under appreciation for their unelected political leaders.

Next up, we watched as again, thousands poured into Rome’s Piazza

dei Santi Apostoli to protest their displeasure with their unelected

political leaders. Whereas Greece continues to hit rock bottom on a

regular basis, the Italians have only begun their long arduous road to

the higher taxes, lower pay and fewer jobs. We suggest all Italians

begin to learn to park their cars in safer neighborhoods.

Meanwhile, the Spanish are also gearing up for their soon to be

regular protests. Whereas Greek and Italian politicians are doing

exactly as are they told by Brussels; Spanish political leaders are still

Spanish “elected” leaders and they have rather colorfully told Brussels

to go fly a kite. Spain can handle their growing debts and deficits on

their own, they don’t need anyone’s help. Exactly what Spain is

thinking we do not know. They’ll learn.

As Brussels did to Italy and Greece, soon enough Spain too will have to

decide whether to accept bailouts from the EU or the alternative of

paying exorbitant interest rates on new debt. Should Spain choose the

bailout route, and they will, they should also be prepared for their very

own unelected-former-Goldman-Sachs-leader.

Now, if global growth picks up, interest rates stay very low, and the

housing market recovers sharply, the Spanish and Italians won’t have

to worry about their cars being overturned. We do hope this happens,yet we remain highly skeptical at this point.

Don’t Panic

For those who haven’t figured it out yet, the daily ups and downs in

the market are certainly not attributed to faster or slower growth and

profits. As it becomes even less obvious to the everyday investor,

April 2012 1982



10

Some Point


today’s markets continue to move at the whim of anything said by the

central banks.

As long as the American Federal Reserve or the European Central Bank

indicate they will continue with money printing strategies, markets go

up. Of course, any hint of a sudden halt to this madness and financial

markets go south as investors head for the hills.

Currently, it appears more and more likely that these central banks will

take a holiday (albeit brief) from money printing. And right on cue,

markets around the World have begun to sell-off. European markets

are certainly taking it on the chin – the Italian market itself has fallenover -15%.

Meanwhile, if you are watching American television you’d think the

World is coming to an end. This apocalyptic tone is certainly

warranted, after all American stocks have fallen -3%. Yes, today a -3%

market decline is enough to create panic in the streets and more

importantly – cause grown Wall Street professionals to actually beg

the American Federal Reserve to print money once again.

Considering this embarrassing behavior from America’s investment

elite, we can only remind people that the stock market can go down as

well as up. And, if a mere -3% move is enough to get people’s dander

up, what will happen if markets fall -20%?

As markets become more and more dependent upon central banks,

the entire concept of free markets is dissolving more and more as it

assimilates into a centrally planned state.

It is very well known today that private companies have billions of cash

burning a hole in their pockets. This is certainly reason to be BULLISH

on the stock market – after all, they have to spend this cash at “some

point.” However, as long as free markets move closer and closer to a

centrally planned state “some point” will never arrive.

Companies will continue to spend the minimum amount necessary to

maintain their businesses – but nothing more until they know their

capital investments will not be affected by random and chaoticmonetary and fiscal policies. As central banks continue to bail out

banks and countries, they implicitly create an investment culture

whereby failure is rewarded and success is taxed to reward those

who failed.

Spain

What can IceCap say that hasn’t already been said? Not much really.

Financial conditions in Spain are deteriorating at a rapid pace. It has

now reached the point where Spanish banks have become completelyreliant upon the Bank of Spain and the European Central Bank (ECB)

for funding.

Banks cannot survive without funding. They will either have to raise

additional equity through financial markets or receive a bailout from

the ECB.

April 2012 1982



11

Everyman


Either way, look for the Euro to come under pressure. And we ask you

not to forget about the Swiss Franc. It’s only a matter of time before

the peg is broken and the Swissie soars once again.

Our Strategy

IceCap is confident that stocks remain in a Secular BEAR Market.

While money printing and bailouts may be providing a respite,

investors must recognise that this is temporary. Eventually

governments and policy makers will reduce their interference in

capital markets and equilibrium valuations will be determined by

private investors.

Until that day comes, it is highly likely that every time central banks

pause from money printing, stocks, commodities and non-USD

currencies will decline. These declines will range anywhere from -10%

to -30%, but when they occur be prepared for central banks to once

again introduce yet another money printing program which will first

stabilise markets and then begin to see investors bid stocks up once

again.

Naturally, this cycle cannot continue into perpetuity. Otherwise, whynot simply print money for everyone on everyday of every week.

Eventually something will happen that will be very difficult for the

central banks to control. It may very well be Spain, or maybe Japan.

Or worse still, what if long-term interest rates rose by a mere 3%?

Whatever it is, it will surely test investors fortitude.

At this very moment, markets are stuck in this lull where both Europe

and America have yet to confirm the next round of money printing.

Meanwhile, Canada and the USA just experienced one of thewarmest winters on record which is skewing some of the economic

data from the first few months of the year. Over the next couple of

months, we’ll get to see whether these local economies are indeed

accelerating or simply benefited from pulling forward spending from

the summer months.

We continue to favour bonds over stocks, and will assess how to

reposition portfolio strategies should this market lull develop into

something more sinister.

As always, we’d be pleased to speak with anyone about our

investment management capabilities. As well, we encourage you to

share our global market outlook with those who you think may find it

of interest.

Please feel to contact:

John Corney at [email protected] or

Keith Dicker at [email protected].

Thank you for sharing your time with us.

April 2012 1982









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