The 17.6 Year Stock Market Cycle

Connecting the Panics of 1929, 1987, 2000 and 2007

Kerry Balenthiran

• Publisher: Harriman House
• Year: 2013
• Print ISBN: 9780857192738
• eBook ISBN: 9780857193094
• Edition: 1
• Topic: Business
• Subtopic: Investments & Securities
• Index: Business

How do we know where we are in the current stock market cycle? Are we in the midst of a new long term bull market or a market rally within an ongoing bear market?The answers to the above questions are critical to forming an appropriate investment strategy to plan for the future. The difference between anticipating the end of a secular (or cyclical) bull market and reacting to the significant crash that follows will have a big impact on anyone's investment returns and retirement plans.This book is concerned with cycles. A cycle is a sequence of events that repeat over time. The outcome won't necessarily be the same each time, but the underlying characteristics are the same. A good example is the seasonal cycle. Each year we have spring, summer, autumn and winter, and after winter we have spring again. But the weather can, and does, vary a great deal from one year to another. And so it is with the stock market.Kerry Balenthiran has studied stock market data going back 100 years and discovered a regular 17.6 year stock market cycle consisting of increments of 2.2 years. He has also extrapolated the cycle forwards to provide investors with a market roadmap stretching out to 2053. He describes this in detail and outlines the changing character of the stock market through the different phases of the 17.6 year stock market cycle.Whether you are an investment professional or private investor, this book provides a fascinating insight into the cyclical nature of the stock market and enables you to ensure that you have the right strategy for the prevailing stock market conditions.

Chapter 1:Commodity Cycles

The twentieth century saw three long commodities bulls (1906–1923, 1933–1953, 1968–1982), each lasting an average of a little more than 17 years.

Jim Rogers, Hot Commodities

The first time I read about market cycles was in the book Hot Commodities by Jim Rogers. Rogers identifies three long-term secular commodity bull markets lasting approximately 17 years. The commodity markets are currently in a bull run that started in the late 1990s. Whether the gold price peaked in a speculative bubble in September 2011 and similarly oil in June 2008 is debatable. But what is clear is that there are cycles that run through the commodity markets and these cycles have a direct impact on the stock market.

The reason for these cycles is straightforward supply and demand, as the following illustrates:

• During the 1970s the oil price spiked in 1973 and 1979 due to tension in the Middle East restricting supply and peaked at nearly $40 in 1980.
• Once supply stabilised prices fell but Western nations realised that they were over-dependant on oil-producing countries and so alternative energy sources such as nuclear were developed, further undermining prices. In addition the high prices weakened demand considerably as consumers moved towards smaller, fuel efficient cars.
• An environment of low oil prices meant that there was little incentive to invest in oil production and new technology and smaller producers/refiners exited the market by being taken over by the oil majors, concentrating supply amongst fewer companies. The oil price hit a low of around $10.
• Once again demand was surging due to a growing economy on the back of low manufacturing prices as a result of the low oil price. However, supply had been steadily declining due to a lack of investment and now oil prices started to rise.
• The oil price increased and peaked at $147 in 2008 and the resulting increase in inflation and interest rates, which reduced disposable incomes, caused homeowners to default on their mortgages and triggered the global credit crunch and subsequent recession.

Similar supply and demand and over/under investment drivers impact all commodity markets and these take many years to filter through to the point where cost effective alternative products and/or sources of supply are available and there is a demand for these alternatives.

Rogers’ book discusses the commodities cycle at length and also touches on how it affects the stock market:-

Studies have confirmed this negative correlation between stocks and stuff. Two recent studies, for example, headed by Barry Bannister, a capital-goods analyst for Stifel Nicolaus and Co., the financial services company, show that for the past 130 years “stocks and commodities have alternated leadership in regular cycles averaging 18 years.”

It looks as if God himself were a trader who enjoyed playing the stock market for 18 years or so and then switched to futures, until he got bored again, after another 18 years or so, and went back into the stock market. ^[1]

The impact of commodities on the stock market

The impact of commodities on stock markets can be thought of as follows: commodities (raw materials) are purchased by producers and manufacturers to make goods, they in turn sell to retailers and ultimately consumers. Consumers use their disposable income to consume stuff and to spend on property.

1. At the beginning of the cycle commodity supply is low; this causes commodity price inflation. Manufacturers respond by putting up prices to maintain margins. Ultimately this reduces demand as consumers have to economise. Consumer spending falls and stock markets fall.
2. The feedback mechanism causes commodity prices to fall, now manufacturers get a boost to their profit margins and company profits and stock prices rise. Competition increases and the economy grows.
3. Increased corporate profitability causes wages to increase and when combined with falling commodity prices, real disposable incomes increase.
4. The economy continues to grow, consumers buy houses or trade up and eventually consumer demand peaks. Demand exceeds supply and commodity prices rise and the whole process starts again.

To summarise, the rising commodity prices increase input costs and reduce company profits, and also consumers’ disposable incomes (demand). Conversely falling commodity prices reduce input costs and boost profits and disposable incomes. As Rogers states:

There is no mystery to it. What could be more straightforward in this world than its very basic materials? Corn is corn, lead is lead, and even gold is just another thing whose price depends on how much of the stuff is around and how eager people are to own it. And there is certainly no magic to figuring out the direction in which prices will go in the long term. These alternating long bear and bull markets in metals, hydrocarbons, livestock, grains, and other agricultural products do not fall from the sky. They are prime players in history, the offspring of the basic economic principles of supply and demand. When supplies and inventories are plentiful, prices will be low; but once supplies are allowed to become depleted and demand increases, prices will rise, just as inevitably. ^[2]

The existence of a commodity cycle makes sense based on supply and demand and associated over/under investment. Studies have confirmed that commodities and stocks are negatively correlated and Bannister has shown that they alternate in regular cycles averaging 18 years.

But why 18 years?

In the following chapter we’ll find out about recognised business cycles of varying lengths that have been identified and the causes of these cycles. We’ll then look at how these cycles impact the stock market and drive booms and busts.

Endnotes

1 Hot Commodities, Jim Rogers. [return to text]

2 Ibid. [return to text]

Chapter 2: Business Cycles — A Historical Perspective

The disadvantage of men not knowing the past is that they do not know the present.

G. K. Chesterton

There is a tendency among people to disregard the past, a belief that the past is history and that it has no role in terms of learning about the future. Past behaviour, in terms of markets and people, can be very insightful in terms of anticipating the future course of action.

Our understanding of business cycles doesn’t appear to have improved significantly since the Great Depression. Prior to 2007 there was a general complacency that the business cycle had been tamed and this complacency arguably contributed to the banking crisis.

The banking crisis of 2007/8 was by no means a one off and by looking back at history we can gain a better understanding of what causes these crises. Much of this knowledge has long since been forgotten, since banking and finance professionals from the early 1900s are no longer with us and are therefore not able to inform people today.

Before getting to the 17.6 year stock market cycle I’ll explore some of the drivers of the stock market, particularly the business cycle identified by Clement Juglar and more specifically the credit cycle that was first documented by John Mills in 1867.

The term business cycle refers to changes in economic activity that reoccur over a number of years. A business cycle comprises periods of growth, stagnation and decline (recession). Once one business cycle ends a new period of growth emerges and the cycle continues. When Juglar first identified the business cycle he called it a fixed investment cycle, however today it is also referred to as an economic cycle.

Juglar, Mills and Kitchin

Juglar, a French physician, was the first to identify an investment cycle of prosperity, crisis and liquidation with a periodicity of between 8 and 11 years, and he believed that prosperity leads to over-speculation that leads to a crisis. This became known as the Juglar Cycle with an approximate length of nine years.

British businessman John Mills presented the theory that business cycles are driven by credit cycles governed by the psychological mood of the masses. Mills believed that business cycles consisted of three periods: after a panic or crisis there will be a post panic period of depressed trade where credit is restricted; a revival period where trade and employment pick up and credit becomes more widely available; and then finally a speculative period where numerous new enterprises are started as cheap credit is easily accessible and capital is mis-allocated again leading to a bust. Mills’ view was that the psychological mood drove the availability and price of credit, i.e. the credit cycle. During the revival period, risk taking gradually increases and demand for credit increases. As lenders see profits increase and defaults decrease, they lend more and the lenders’ risk taking increases. The revival period leads to speculation and then crisis, where mounting capital losses cause risk aversion among lenders and credit is restricted to the very best borrowers. Mills advocated that each period lasted approximately three years and that these three periods of three years would repeat periodically ad infinitum. John Mills is quoted as saying:

Panics do not destroy capital; they merely reveal the extent to which it has been destroyed by its betrayal into hopelessly unproductive works. ^[3]

Dr. Warren F. Hickernell summarises the Mills Theory in Financial and Business Forecasting (1928) as follows:

Mills bases his credit cycle theory upon two main elements; first, the tendency of human nature to exaggerate prospects for prosperity when prices rise and to underestimate business opportunities when trade is depressed. The second factor is the rate of interest, which causes wide-awake and intelligent men to expand operations when capital is abundant and to curtail operations when credit is dis-intended relative to metallic banking reserves. ^[4]

In addition to the nine year cycles above, American economist Joseph Kitchin discovered a shorter cycle lasting between 40 and 59 months (3 1/3 to 5 years) that was attributed to the time lag between raw materials building up in inventories and businesses reducing output in response to falling demand.

Kuznets, Kondratieff and Schumpeter

Further cycles were identified by the American economist Simon Kuznets (a 15 to 25 year demographic/building cycle for which he won the Nobel Memorial Prize in Economic Sciences).

Russian economist Nikolai Kondratieff discovered a 45 to 60 year cycle. However the Kondratieff cycle is not accepted by modern economists due to the inability to identify a cause and also disagreement over identifying when these cycles start or finish. The cycle that Kondratieff identified appeared to cease in the post war period, which has caused many to question whether the Kondratieff cycle really exists at all, although Korotayev and Tsirel have found evidence of ...

Table of contents

• Table of Contents
• Publishing details
• About the author
• Introduction
• Chapter 1:Commodity Cycles
• Chapter 2: Business Cycles — A Historical Perspective
• Chapter 3: Business Cycles — A Modern Psychological Perspective
• Chapter 4: Balenthiran 17.6 Year Stock Market Cycle
• Chapter 5: How To Trade The Balenthiran 17.6 Year Stock Market Cycle
• Chapter 6: Conclusion
• APPENDIx
• BIBLIOGRAPHY
• Investing books from Harriman House