The Independent Market Observer

5/16/14 – What Can Cycles Tell Us About Investing?

Posted by Brad McMillan, CFA®, CFP®

Find me on:

This entry was posted on May 16, 2014 12:30:00 PM

and tagged Commentary, On My Bookshelf, Ask Brad

Leave a comment

If you ever want to be amused, get a cat to watch an ink-jet printer while it’s at work. I now have a laser printer at home, which still seems to fascinate the cat, but there’s no comparison to the ink-jet. Something about the print head scurrying back and forth under the cover must remind them of a mouse . . .

As you’ve probably guessed, it’s a slow news day. Markets sold off a bit yesterday, perhaps a normal reaction to new records as investors took profits—nothing particularly noteworthy.

Looking at cycles: just hocus-pocus?

I’ve written recently about how we’ve returned to something approaching normal (and how that’s a good thing). Now is also a good time to examine what “normal” means in 2014, as the definition changes significantly over time. What we consider normal now is very different from 30, 20, 10, or even 5 years ago.

But some things remain the same, and that’s where the conversation gets interesting. I wrote some time ago about The Fourth Turning, a book that uses generational demographics to describe social trends. Witchcraft, you might say, but it has had a surprisingly good record of predicting many social changes over the past couple of decades, including the great financial crisis of 2008.

On the recommendation of a Commonwealth advisor, Nancy Camacho, I’m now reading Cycles: The Science of Prediction. Written in 1947, the book doesn’t even have a Kindle edition. (Imagine that!) Given the publication date, we now have almost 70 years of data to see how the theory worked. For the stock market, the book predicts bottoms around 1969, 1988, and 2007, and peaks around 1960, 1980, and 1999. Not perfect, certainly, but pretty good in my opinion, especially for an analysis done in 1947. And that’s only one cycle of many described in the book. It also predicts that the 1969 and 2007 busts would be especially severe, as several cycle bottoms overlap.

Cutting back to the present, what about the idea, which I mentioned the other day, that phases of the moon actually affect stock returns? (Don’t blame me, read the paper yourself.) Or the presidential election cycle’s apparent influence on returns, noted by none other than Jeremy Grantham? (Of course, he goes on to say that most investors would be embarrassed to admit they considered it.)

In this light, maybe there is something to using economic cycles as a way to frame an understanding of the big picture.

But would I trade on this type of information?

No, I wouldn’t. Rather, its value is in forcing us to take our eyes off the trees so that we can see the forest. Just as with demographic analyses, considering the macro trends acting on the world may help us put more short-term developments in context.

I’ll admit that I take some comfort in the fact that the trends described in Cycles indicate a continuing market upswing until around 2016, right about the time the U.S. government will have to come to grips with entitlement spending—a need driven by generational, demographic trends. Coincidence?


Subscribe via Email

New call-to-action
Crash-Test Investing

Hot Topics



New Call-to-action

Conversations

Archives

see all

Subscribe


Disclosure

The information on this website is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Please contact your financial professional for more information specific to your situation.

Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets.

The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. All indices are unmanaged and investors cannot invest directly in an index.

The MSCI EAFE (Europe, Australia, Far East) Index is a free float‐adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada. The MSCI EAFE Index consists of 21 developed market country indices.

One basis point (bp) is equal to 1/100th of 1 percent, or 0.01 percent.

The VIX (CBOE Volatility Index) measures the market’s expectation of 30-day volatility across a wide range of S&P 500 options.

The forward price-to-earnings (P/E) ratio divides the current share price of the index by its estimated future earnings.

Third-party links are provided to you as a courtesy. We make no representation as to the completeness or accuracy of information provided on these websites. Information on such sites, including third-party links contained within, should not be construed as an endorsement or adoption by Commonwealth of any kind. You should consult with a financial advisor regarding your specific situation.

Member FINRASIPC

Please review our Terms of Use

Commonwealth Financial Network®