What you see above is an inflation adjusted historical chart for the S&P (courtesy of dshort.com). The blue lines are Secular bull markets and the red lines are Secular bear markets. Secular markets can be decades in length but typically last around 15 years. Within any Secular market you can have Cyclical bull or bear markets (follow me here). A Cyclical market can last 2 to 3 years and be counter trend to the overall bigger picture Secular market. For example: Based on the chart above we entered a Secular bear in 2000, however since March of 2009 we have technically been in a Cyclical Bull. Does this make sense?
So how does this relate to my question of does Asset Allocation work? and why am I still feeling a bit defensive?
Asset Allocation works great in Secular Bull Markets and in some cases the beginning stages of Secular Bear markets. (Small Caps and Real Estate held up well during the Large Cap Growth carnage of 2000 to 2002.) However at this stage in the Secular Bear they are highly correlated with every other asset class in the market.
Asset Allocation will still work for those of you with longer time horizons, so don't rush out and begin changing your 401k's. It just may take some time for us to enter another Cyclical Bull for that to happen.
As to why am I still feeling a bit defensive here? Its that I don't think this Secular Bear is over for a few more years. I could of course be completely wrong and be kicking myself for having clients underweight in equities, however a wise man once said "opportunities are made up easier than losses".