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

Posted by Brad McMillan, CFA, CAIA, MAI

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

and tagged Commentary, On My Bookshelf, Ask Brad

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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?

Upcoming Appearances

Tune in to Bloomberg Radio's Bloomberg Businessweek on Friday, February 28, at 3:45 P.M. ET to hear Brad talk about the market. Stream the show live at https://www.bloombergradio.com/, listen through SiriusXM 119, or download Bloomberg's app, Bloomberg Radio+.

Tune into Yahoo Finance's The Final Round on Thursday, March 12, between 2:50 and 4:00 P.M. ET to hear Brad talk about the market. Exact interview time will be updated once confirmed. Watch at finance.yahoo.com

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