The Long Run

"The book Stocks for the Long Run was written by Jeremy Siegel in the mid-1990′s. The premise is that if you just buy and hold stocks over a 20 to 30 year period, you will always make money. This was exactly what the Wall Street witch doctors ordered. They pounded this message into the brains of every American incessantly in their advertising campaigns, literature and propaganda. It became an unquestioned truth. Just one problem. It isn’t the truth. Valuations matter. The Dow Jones was at the same level in 1982 as it was in 1966. On an inflation adjusted basis, the Dow did not get back to the 1966 level until 1990. That is 24 years of no return in the stock market. The American public ignored the true facts and piled into equities during the late 1990s. The result was one of the greatest examples of mass delusion in history. The internet bubble drove the NASDAQ market to a peak of 5,048 in March 2000. Today it sits at 2,180. Ten years after the bubble burst, the NASDAQ is still down 57% from its peak."
James Quinn, TheBurningPlatform.com

Cascading Bubbles

For reasons unknown, I've never really liked the term "bubble", but due to a lack of a better term, I'll use it today to illustrate a point.  I've always liked the phrase "overshoot and collapse" which is used in the biological realm to explain the rapid growth and subsequent crash in the population of a given species.  That's a subject for a later post.

I thought it would be interesting to analyze the impact of the money supply through time on various "bubbles".  The chart below illustrates quite beautifully how the money supply (M3-black dash) impacts the rise and fall of all markets.  The chart compares 5 asset types: technology, financials, oil, homebuilding, and wheat.  These all have experienced drastic "rise and falls" since the mid to late 90's.  Many commodities followed the exact pattern, but I used oil and wheat as two examples.  Click on the chart for a larger view.

Observations that can be made:

1. 
   
   M3 (money supply) rises in the early 80's (Reagan), flattens in late 80's (Bush I), rapidly accelerates in 1995 (Clinton), and keeps rising rapidly after 2000 (Bush II).
2. 
   
   Reagan pulls us out of the doldrums not by magical things called "trickle down" or "supply side", but by turning on the "money supply accelerator" in the early 80's.  Note the M3 Rate of Change curve on the bottom.  A trending up curve indicates a rapidly increasing money supplly while the downtrend is decelerating.
3. 
   
   The Great Maestro, Alan Greenspan, pulls off the accelerator in 1988 and Bush I loses re-election.
4. 
   
   Note that during the "flat" M3 from 1988-1995, the markets are aligned and flat. 
5. 
   
   In 1995, Clinton leads the public to believe that he magically makes the deficit disappear and balances the budget.  Meanwhile, the money supply starts a significant upward climb.  Note the M3 Rate of Change on the bottom of the graph.  It rises rapidly.
6. 
   
   Subsequent with the rapid rise in M3 in 1995, the markets go into "chaos" mode.  The money supply drives the financials and technology through the roof.  Note the steepness of the curves after 1995 in all sectors.  The end result is the DotCom mania.  Now we understand where all of that crazy investment and venture capital money came from!
7. 
   
   DotCom crashes only to see the "credit bubble" move into financials, homebuilding, and commodities (oil/wheat).  2001 marks a "new beginning".  Same game, but different sectors.
8. 
   
   The markets all align in late 2008 subsequent with the steepest rise in M3 Rate of Change.  Then they ALL come crashing down.  As Robert Prechter with Elliott Wave International has stated, "all the same".  Equities and commodities crash together in perfect synchrony.
9. 
   
   Money supply has significant impact on the markets.  While the Federal Reserve was supposedly created to help "nudge" the market when it needed assistance, the contrary is presented from this 30 year history.  After 1995, it looks more like a heroin junky flying up and down.

The Psychology Of The Investment Cycle

As I've stated in the past, my main interest revolves around mass human psychology. The graphic below summarizes the evolution of human psychology through the investment cycle. We start with optimism (1982), it grows into excitement and thrill (80's/90's), and finally has a grand finale filled with euphoria (1997-2000)! Can we say DotCom stocks?

SOURCE: Memoirs of Extraordinary Popular Delusions and the Madness of Crowds, by Charles MacKay, Published in 1841

As the markets start to "rollover", we become anxious (1999-2001: stock meltdown, 9/11). This anxiety, fueled by the media, evolves into a brief state of denial (2001-2007). The realities appearing on the news every night transform into a state of fear (2007-present). The denial has ended and most realize that we have some serious problems that will take some significant time to resolve. The fear gets reinforced by the media and the constant replay of the progressing negative developments. The cycle forecasts that depression, panic, capitulation, and desperation await us.

So what should we do? Now that you realize that we're evolving through a natural cycle and you know what is coming next, then plan accordingly. Protect the things most important to you. Most importantly, remember that hope, relief, and optimism will always be waiting on the other side (2014-16). After the cold winter, spring emerges and fresh flowers are once again growing with their amazing beauty. Patience, knowledge, vision, leadership, relationships, and faith will guide you well.

Additional versions of the concept:

Sources: RMB Unit Trusts, thefinancialhelpcenter.com

The Dow Jones Industrial Average / Gold Ratio: Timeframes

This is the third installment of a series on the DJIA/Gold ratio. In the past two posts, the ratio has been presented over the past one hundred years. The chart below depicts the timeframes for the cycles and phases. The earliest cycle depicted on the graph experienced a 32 year expansion culiminating in the Roaring 20's. This euphoric party came to a crashing halt in 1929 with the DJIA correcting 89%. While the initial crash lasted 2.85 years, the contraction phase lasted 13 years until 1941 when the next expansion cycle began. The expansion phase represented 71% of the cycle's overall length. The entire cycle reprented a total of 45 years.

Expansion returned in the early 40's as WWII occurred. As they say, there's nothing like a war to stimulate an economy and workforce. The post-war boom in the 50's was significant with growth occurring in most industries. The "happy days" of the 50's were good times for most. This expansion phase lasted 23 years until 1964. The inflection point between these two phases aligned with significant social disorder and crises. This contraction encompassed the hippie 60's, major racial conflict, assassinations of several major figureheads, and ended with the inflation and oil embargo of the 70's. The contraction phase last 15 years and represented 40% of the cycle time. These were challenging times and the entire cycle reprented a total of 38 years.

The current cycle kicked off the expansion in 1980. Carter's challenging presidency was coming to a abrupt ending, and Ronald Reagan was about to time the next expansion very well. The 80's and 90's represent what will likely be documented historically as the greatest credit expansion of all time. During this expansion, just about everything expanded with stocks reaching astronomical levels. The rise lasted 18 years until 1999 when the contraction phase began. The DotCom Era was the appropriate euphoric finale to an incredibly expansionary period. Many would argue that the expansion lasted until mid-2007 when the credit market imploded. The value of understanding this ratio has never been more significant. The stock market corrections commenced in 2000 and lasted for several years. The "last hurrah" in 2007 illustrates the power of the Federal Reserve's manipulation via the money supply. It's now obvious to all that this level was purely manipulated and that the DJIA/Gold ratio was telling a very different story. This last eight years also illustrates the forecasting strength of the ratio.

The $64,000 question now is "when does the contraction phase end?". Using the cycle lengths of the prior two cycles would indicate that this contraction phase could last 13-17 years. With a beginning in 1999, that puts an end somewhere in the 2012-16 timeframe. Note that in the first cycle, the DJIA bottomed in July 1932, but the next expansion did not commence for eight more years.

Several other observations can be made from this ratio over the past 100 years. The expansion phases appear to average 2/3's of the cycle while the contraction lasts 1/3. Growth appears to be gradual, while contraction is more abrupt. A second observation is that the expansion cycles continue to be shorter (32-23-18 years). The most recent expansion, while the shortest, had the steepest growth. The contraction after the Roaring 20's illustrates that a short rise is usually followed by a sharp fall. This time should be no different. The last observation is probably the most significant and timely. Over the three cycles, the "highs got higher" and the "lows got lower". If this trend continues for this contraction phase, the low could be frighteningly low. This being the "lowest low" in the past 100 years.

The prior posts in this series:

http://randomroving.blogspot.com/2009/02/dow-jones-industrial-average-gold-ratio.html

http://randomroving.blogspot.com/2009/02/dow-jones-industrial-average-gold-ratio_18.html

PDF's of these charts can be downloaded at:
http://sites.google.com/site/randomroving/Home