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Kirk's Interpretation of Bob Brinker's
5 Root Causes of a Bear Market
September 7, 2007
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This article examines Bob Brinker's 5 root causes for a bear market. Please post your questions in our "Bob Brinker Free discussion forum" at facebook's "Investing for the Long Term."

In Bob Brinker's January 2000 Marketimer he published his "Five Root Causes for a Bear Market."

I believe not enough of Bob Brinker's "5 Root Causes of a bear market" are present today so Brinker will remain bullish. Before I examine the causes in detail, lets look at them in an historical perspective.

The 5 root causes of a bear market, according to Bob Brinker, are:
  1. Tight Money:
  2. Rising Rates:
  3. High Inflation:
  4. Rapid Growth:
  5. Over Valuation:
In January 2000, Bob Brinker advised taking 60% out of the market because:
  1. Tight Money:  He said the Fed was reducing M2 to slow growth - BEARISH and correct as economic growth collapsed.  This chart of M2 money supply growth shows the Fed Cut it to below zero in early 2000.

  2. Rising Rates:  He predicted higher long and short term rates to continue. This did not happen but it was - BEARISH for his model..

  3. High Inflation:  He said the CPI was approaching 3% and import prices were up 5% which would further impact inflation. We didn't get high inflation, but this was BEARISH for his model none the less.

  4. Rapid Growth:  Real GDP growth was approaching 5%. Bob felt the FED would use rates to try and slow this. This was BEARISH and correct.

  5. Over Valuation:  Bob wrote: "We believe valuation levels in the U.S. market are stretched to the limit." BEARISH and correct.  Market PEs were at record levels

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All five of his root causes were BEARISH in January 2000. On the radio program at the time, he said he was not bearish, but the odds favored a decline over the market going up more than 5%.

Brinker recommended reducing the equity allocation from 100% to 40% in his model portfolio numbers one and two. He also lowered his Model Portfolio III (which is a balanced portfolio) equity allocation from 50% to 20%.

Here are some newsletter quotes from early 2000:

January 8 2000 Marketimer: "The Marketimer stock market timing model has turned unfavorable....We recommend raising a 60% cash reserve at this time."(S&P500 = 1402.13; DJIA = 11122.65, QQQQ=86.25)

February 2000 Marketimer: "The Marketimer tactical equity asset allocation change in January has placed subscribers in a strong position as the market continues to deal with several unfavorable factors....."

April 2000 Marketimer: "The Marketimer stock market timing model remains cautious as the second quarter gets underway........"

April 2000
Marketimer:  "Marketimer recommends the following investments as our best ideas for 1999 I.R.A. contributions, which can be made through April 17, and Year 2QQO contributions. Each investment should be selected based on your personal investment objectives and should be integrated as part of your overall asset allocation strategy managed from the top down.

Equity Funds: Aggressive:
Janus Olympus JAOLX (Did so bad they shut the fund in 2006!)
Strong Growth SGROX
Growth: TIAA/CREF Growth Equity Vanguard Total Stock Market .
: Fidelity Utilities: FIUIX
: TlAA/CREF International Equity
Fixed Income
: Ginnie Maes: Vanguard Ginnie Mae Fund

These selections represent funds which we believe are excellent investment vehicles for each investment objective category. We recommend I.R.A. accounts as vehicles for tax deferred investment and we suggest maximizing the I.R.A. accounts available to you. "

In August of 2000, when the market was a bit higher, Brinker recommended taking another 5% out of equities for a 65:35 Equities-to-Cash asset allocation. 

Had Brinker remained at 65% cash reserves until returning to fully invested in March 2003, he would have looked brilliant.  Unfortunately,
in October 2000 Brinker recommended putting 20 to 50% of cash reserves back into the market via the NASDAQ100 (QQQQ Bulletin ) for a counter trend rally despite saying his model had not given a buy signal. The QQQQ trade was a disaster, but his long term model was correct to predict further weakness because 2001 and 2002 were both down years for the markets.

The markets bottomed in October 2002 and his model correctly gave him a bullish buy signal within 5% of the S&P500 bottom in early 2003. Since returning to 100% invested in March 2003, Bob Brinker has correctly remained fully invested with no QQQQ-like side trips to hurt his performance.

Now, let's look at the 5 Root Causes of a Bear Market as of May 31, 2007:

  1. Tight Money. Economagic.com shows the growth of M2 Money Supply is positive at 9.72%. I rate this as BULLISH even though Bob has been upset with the Federal Reserve for raising the Fed Funds rate above 4.5% to its current 5.25%.
  2. Rising Rates: The idea behind this indicator is one of the ways to start a bear market is for the Federal Reserve to start a recession by going to far in raising rates. Brinker was correct that the Fed tightned too far in 2000 but so far in 2007, the Fed seems to have learned its lesson and is doing a great job.After the Fed raised rates to 5.25%, Bob said on the radio Saturday 06/03/06 that he thought the Fed had gone too far and will have to lower rates. He says they should have stopped at 4.5%. The Federal Reserve has raised short-term Interest rates from a low of 1.0% on June19, 2004 to their current 5.25%. After an historic 17 straight rate increases, the Fed has held rates steady at 5.25% . The 10-year Treasury bond remains "well behaved" at 4.90%. Bond investors have long term rates lower than short term rates as they believe the Fed will do what it takes to get core inflation back under 2.0%. Bob recently said "the Fed will eat crow " and lower rates to prove he was right all along about higher priced oil not being inflationary. I think that is like telling a fireman after they put out a fire "you didn't need to put water on the fire. It went out just as I said it would." You have to love Bob's modesty! I think Bob has had this indicator BEARISH while I have it as neutral or even bullish.
    Note, in past updates, I had this as BULLISH but I now think that was a mistake. I was using my interpretation of the data rather than Bob's interpretation of the data. Brinker has said many times he thinks the FOMC should have the Fed Funds rate between 4.0 and 4.5%, not its current 5.25% level, thus I think Brinker views this as BEARISH.
  3. High Inflation: Despite the inflationary pressures of higher food and energy, Federal Reserve monetary policy (including higher rates) has kept inflation from getting out of control . Sure higher priced commodities, especially oil, has core inflation above the one to two percent "comfort zone" for the Federal Reserve, but inflation is still well below the problem levels of the 1970's and 1980's. Unlike Brinker, I believe the Federal Reserve, led by Allan Greenspan and now Ben Bernanke, has done a fantastic job of deflating the housing bubble and limiting the inflation effects of higher priced oil without sending us into another recession. Overall, this is BULLISH
  4. Rapid Growth: This is not a problem. In fact, GDP has been below trend mostly due to the Federal Reserve keeping rates high to control inflation. Q1-2007 GDP growth was estimated to be only 1.3% after Q4-2007 came in at 2.5%. Today the government announced GDP came in at a very weak 0.6%, the lowest since Q4 2002 when it grew only 0.2%. On the radio, Bob said he is not calling for a recession. ECRI is calling for growth to improve, but they are not looking for rapid growth. BULLISH
  5. Over Valuation: In the June 2007 issue of "Kirk's Investment Newsletter," I wrote in "Standard and Poor’s estimates 2007 "Bottoms Up" operating earnings for their S&P500 index will be $94.11, up from $93.01 last month. At $1,501, this gives a price to earnings ratio (PE) of 16.0 on 7.3% earnings growth over 2006. The earnings yield, inverse of the PE, is 6.3% for 2007. The PEG, PE over earnings growth rate, is 2.2. The 10-year US Treasury bond is yielding 4.70%, well below the S&P500 earnings yield so the market is not over valued according to the “Fed Model.” Despite the recent record level of the S&P500 and the Treasury yield increasing to 4.90%, the PE and earnings yield are still quite BULLISH.

Sept 7, 2007 Update: I wrote the above five months ago. Did I make a mistake on any of these five indicators? I had all FOUR as BULLISH and ONE BEARISH the way Brinker looks at his model. TODAY, Brinker seems to think the Fed is going to lower rates and he seemed happy with Ben Bernanke whom he said made "rookie mistakes" in raising rates. So TODAY I have all five as BULLISH!

Agree or disagree, I believe Bob Brinker will continue to be bullish.  What do you think?

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