Saturday, November 16, 2013

The 17.6 Year Secular Stock Market Cycle Update

The following article from Sy Harding reviews so many of the ideas I wanted to discuss this weekend (particularly the 17.6 year secular stock market cycle and retail buyers entering the market) that I will post it in its entirety.

Why It's Still Only A Cyclical Bull Market Within The Long-Term Secular Bear.
November 15, 2013.

In 1999 Warren Buffett famously warned that “The next 17 years will be quite unlike the last 17 years. It might not look much better than the dismal 1965-1982 period.”

He was referring to the market’s history of cycling between long-term ‘secular’ bull and ‘secular’ bear markets, as it has done for at least 113 years.

In 1999, the last 17 years Buffett was referring to encompassed the powerful 1982-1999 secular bull market. During that period, cyclical bear markets still took place, like the 1987 crash, the 1990 bear market, and the 1998 mini-crash. But when they ended, the long-term bull market resumed to ever higher new highs.

However, during the previous period of 1965-1982 that he referred to, cyclical bear markets also periodically took place. But when they ended, the next bull market only returned the market to the vicinity of its previous highs, and then collapsed again.

So far, Buffett has been right that the 17 years beginning in 2000 would be more like the period of 1965-82 than the 17 years of 1982-2000.

Here are a few of many reasons to believe he will continue to be right, that the cycle will not end until the 17 problem years he envisioned are up in 2017:

By most measurements, like Tobin’s Q, Nobel Laureate Robert Shiller’s CAPE ratio, and Warren Buffett’s favorite valuation method (the ratio of total market capitalization to annual GDP), the market has reached substantially overbought and overvalued levels again.

Then there is investor sentiment. Retail investors have fallen back in love with the stock market to a significant degree. According to the Investment Company Institute, as is typical in the cycles, public investors, devastated by the 2007-2009 bear market, pulled money out of the market through the first three years of the new bull market that began in 2009. But they have been pouring money back into equity funds at an increasing pace since mid-2012, reaching a near record $92 billion in the first half of this year, (even as data shows institutional investors have been cutting back their exposure).

The last time retail investors became as enthusiastic and confident was in 2007, when they moved $85 billion into equity mutual funds in the first seven months of the year. So by that measure anyway, greed has replaced fear to an even greater extent than near the serious market top in October, 2007.

It also should not be ignored that we are in the first two years of the Four-Year Presidential Cycle. Its long history is that the first two years tend to be negative, and if there is not a correction in the first year the odds increase that a serious correction, even a bear market, will take place in the second year, which next year will be.

There is also the statistic that there have been 25 bear markets in the last 110 years, or one on average of every 4.4 years. This bull market was 4.4 years old in August.

There are numerous potential catalysts in place to roll it over the top, not the least of which is that by next spring at the latest, the Federal Reserve is highly likely to be tapering back the stimulus and easy money policies that have been the main driving force of the bull market.

The combination of conditions is such that, while I am a firm believer in the remarkable consistency of the market’s annual seasonality, I am not completely confident that seasonal strength will last all the way into the spring or early summer this time as it usually does.

If Buffet was right that the secular bear would last 17 years, and others are right in worrying that the high valuation levels, overbought technical conditions, investor euphoria, and so on indicate the next cyclical bear market is right around the corner, then we need to be aware that neither seasonality nor a friendly Fed are always enough to prevent the market from topping out.

The S&P 500 topped out into the serious 2000-2002 bear market on March 23, 2000. And it topped out into the 2007-2009 bear market on October 9, 2007. Although in both cases it recovered some before the end of the favorable season, those dates, within the favorable seasons, were the market tops.

Investors probably need to temper the current level of greed and euphoria with awareness of how closely conditions are working out as Buffett envisioned, and the high odds of at least one more cyclical bear market within the secular bear before enthusiasm buy and hold investing can be trusted again.

Sy Harding is president of Asset Management Research Corp, and editor of, and the free market blog, He can also be followed on Twitter @streetsmartpost

Jim Rickards Discusses The Moving Pieces On The Currency War Chess Board

Thursday, November 14, 2013

1999 vs. 2013: This Time It Is Different

An incredible statistic and chart posted this morning at Phoenix Capital Research. Most people believe that while the current technology market is a bit frothy it is in no way near the manic bubble that was taking place in 1999. Really?

This year 73% of the tech companies that have gone public have never turned a profit.

How does that compare to the mania in 1999?

That year only 27% of the tech companies were unprofitable.

The NASDAQ fell 80% after the last tech mania ended in 2000. I'm sure this time with a far larger percentage entering with no profits it should turn out much, much better. The full list of this year's madness is below. Get em while they're hot.

Tuesday, November 12, 2013

The Dragon King Waits In The Shadows

The following chart was published by the Bank of England (the U.K.'s central bank) in 2011. The fact that a central bank would publish an image this honest is shocking, but what is shows is the diminishing impact of Quantitative Easing (money printing) over time.

When the QE program is launched, the initial impact is dramatic with both asset prices and real GDP responding in kind. Over time you begin to move into the darker portion of the QE program where you get less (or even falling) economic improvement while consumer prices continue to rise at a faster and faster pace.

This concept has been a topic of discussion recently for some of the top fund managers around the world as they have noticed that while stock, bond and real estate prices have surged higher, the underlying economy is dragging along at a sluggish zombie like pace. Ray Dalio, who manages the Bridgewater Associates hedge fund which became the largest in the world with over $120 billion in funds in 2011, provided the following Marginal Effect chart in his most recent letter.

One of the Fed's main goals when implementing the QE program is to drive asset prices higher. This causes people to feel more wealthy and makes them more likely to spend money. If they spend money, then the economy will grow and the money will "trickle down" to the rest. This is just the theory of course which worked well during the 1990's (when Alan Greenspan first embarked on the wealth effect journey) but has steadily fallen in impact over the last 18 years.

What the Bank of England and Ray Dalio did not discuss is what the impact would be should the QE program begin to be unwound. If the greatest positive impact on asset prices occurs during the initial launch of QE, would it not make sense that the greatest negative impact on asset prices would occur during the early stages of the unwind? This is why you saw markets completely rocked around the world when the Fed uttered the word "taper" back in May. Just the thought of the unwind beginning shook the financial system.

This has created the vicious circle the central banks have now trapped themselves in. Understanding that they are creating asset bubbles, which are now popping up almost everywhere, they have no choice but to continue onward and just pray.

One of Warren Buffett's favorite tools to measure froth in the stock market is to take U.S. GNP and divide it by the total market cap value of the Wilshire 5000 Index. This index crossed over 100% in the late 1990's market surge before reaching 150% and once again crossed over 100% in 2007. We have crossed back over the 100% danger point this year as seen in the graph below.

The Shiller P/E ratio and Tobin's Q ratio are both sitting at previous secular bull market highs.

Sentiment indexes are surging as the tech heavy Hulbert NASDAQ sentiment index is at euphoric highs.

Didier Sornette, author of "Why Stock Markets Crash," has spent the last few years studying chaos theory and something he calls "Dragon Kings." While a Black Swan is an event that is truly undetectable before it arrives, such as a severe weather event, he believes that a Dragon King is an event that occurs more often, is possible to predict, but still creates a mass level of chaos. One of his fields of study is the stock market.

A main tool used by Sornette to determine whether a bubble and subsequent crash is upon us is to look at the wave structure of the market. A cyclical bull market begins in wide waves which can be seen in the chart below. As the market progresses the waves become tighter and tighter until they reach the point of a blow off top. While all the tinder is in place (listed to the left of the chart) for a market collapse now, the chart shows that a final blow off top could just as easily come before the crash. The blue line in the graph below shows the S&P 500 while the red line tracks a typical Dragon King event.

For more on Sornette's work see the recent Wired article; Using Chaos Theory To Predict & Prevent Catastrophic Dragon King Events, Sornette's most recent paper; Financial Bubbles & Finite Time Singularity Models and the video below:

h/t John Hussman, MSN, Street Talk Live, Short Side Of Long