Stock Market Cycles

Stock Market Cycles: What My #1 Predictor Is Saying Now (The Forecast Ain’t Pretty)

by Mark Skousen, Chairman, Investment U
Friday, June 23, 2006: Issue #549

Investors are always trying to find a short cut to forecasting the stock market’s cycle and direction. I remember years ago, in the late 1980s, a “doctor” named Ravi Batra who wrote a book called The Depression of 1990.

He warned that the capitalist system always goes through a regular cycle of boom and bust that lasts approximately 60 years, known elsewhere as the Kondratieff Cycle (named after a Russian economist). Since the last depression began in 1930, the next one could be pinpointed with precision – 1990. The October 1987 crash confirmed Batra’s worst fears. More was on the way. By the time 1990 arrived, the U.S. was in the beginning of a recession, and Batra’s book gained notoriety. It reached #1 on The New York Times bestseller list.

But the second Great Depression never arrived; 1990 turned out to be a great time to buy – not sell – stocks, and Batra was discredited. The fact is that there is no mechanical reason why human beings are forced to go through a 60-year cycle. The Kondratieff Cycle has proved to be elusive.

Cycles in stock markets do exist, but it’s impossible to pinpoint how long they will last with any precision. Much depends on the actions of government officials and the intelligence of the public. Each time is different. I recall commentators calling for a six-year gold cycle, or a 10-year real estate cycle. They are all ephemeral, because, as Shakespeare says, our actions are “not in the stars, but in ourselves.”

Who Can Forecast the Stock Market’s Cycles and Future?

In last Sunday’s New York Times, Mark Hulbert gave credence to another simple predictor by two professors of finance at Baylor University. By focusing on three ingredients (the stock market’s dividend yield, the T-bill rate, and average earnings expectations of Value Line’s 1,700 stocks), they have created a model that is predicting a bear market through the end of next year.

I won’t go into the details of this model because it failed miserably to predict the biggest bull market in history in the 1990s! Yet Hulbert is somehow convinced that we should pay attention to this strange model.

Subscribers to Investment U know that I have recommended caution and a high cash position in the past month or two. I don’t base my forecasts on mindless technical systems, cycle theory or back testing.

Instead, my stock forecasts are based on the “signs of the times”

Geopolitics,
Macroeconomics, and especially
Monetary policy.

My motto is simple: “Don’t fight the Fed.”

There are several forces emanating from the Federal Reserve Building in Washington D.C. that are threatening Wall Street’s long-term bull market:

1. Ben Bernanke is determined to prove himself as an inflation fighter.

As his first year as Fed chairman, Ben Bernanke wants to build a reputation equal to his predecessor, Alan Greenspan. It’s a tall order. He will try to accomplish this goal by raising rates even further, creating an inverted yield curve, which is highly negative for stocks (Refer to the chart listed below). So why take risks in stocks, or even bonds, when you can earn over 5% in cash? (Or 8% in prime rate funds, my favorite investment vehicle right now.)

Stock Market Cycles & Inverted Yield Curves

2. Ben Bernanke & the Fed have clamped down on the growth of the money supply.
This is the second leg of “tight money,” and the most dangerous. As I pointed out in Investment U # 542, until early this year, the Fed was printing money like water, at a 6%-10% clip. However, since March, M2 has stopped growing entirely.

Warning: I know of no time in my memory when the Fed has raised rates and tightened monetary growth without creating a short-term bear market in stocks.

3. War is inflationary, which will make it difficult for Bernanke to maintain this tight money policy for long.
I suspect that we are going to see a financial crisis building that will force his hand to reverse course and begin another round of monetary easing.

Prepare for a hot thunderstorm or two on Wall Street this summer. For those seeking shelter, there’s nothing wrong with money market funds earning 4.5%, or prime rate funds earning 8%.

Good investing,

Mark

Any investment contains risk. Please see our disclaimer

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