Stock Cycles May 2010
Progress of the secular bear market: position
as of April 30, 2009
The value for R is 1590 as of April 2010. For S&P500 of about 1170 this gives P/R of 0.74.
Progress Update on the Kondratiev Cycle
The Kondratiev cycle is a 50-60 year cycle in prices, interest rates and other economic variables. It was noted as early as 1847 in an article in the British Railway Journal by Dr. Hyde Clark, but it was N. D. Kondratiev who first described the cycle in detail and for whom the cycle is named. Kondratiev cycles are most readily apparent in monetary data such as prices and interest rates. Figure 1 shows a plot of the US producer price index over the period 1800 to 2000. Prior to WW II, the Kondratiev cycle could be readily identifed as periodic peaks and valleys in commodity prices spaced about fifty years apart. Since WW II secular inflation has obscured the cycle, requiring data manipulation to visualize the cycle.
Previously I developed the concept of monetary stimulation and used it to remove the effect of secular inflation so as to reveal the underlying Kondratiev cycle. Stimulation (S) is defined as the sum of market-outstanding federal debt (cumulative deficits) plus M3 money supply divided by the GDP:
- S = (cumulative deficits + M3) / GDP
The price index was regressed against stimulation and the regression equation used to calculate what price "should be" as a function of S. The actual price level is then divided by this calculated price to obtain what I called reduced price. Figure 1 shows a plot of reduced price for the US for the period 1791-2010.
Figure 1. A plot of reduced price showing Kondratiev cycles in the US since
Figure 1 shows four Kondratiev peaks: 1814, 1864, 1918, and 1981. Four Kondratiev troughs can also be seen in 1790, 1842, 1896 and 1946. The peak to peak and trough-to-trough spacing defines the Kondratiev cycle of average length just under 56 years. We call the period of rising prices, between the Kondratiev trough and the Kondratiev peak, the Kondratiev upwave, or just upwave. Conversely, we call the decline from the peak to the trough the downwave. The most recent Kondratiev extrema was the peak in 1981, putting us in the midst of a downwave with the Kondratieve trough still in the future.
If we examine each downwave closely we see that after each Kondratiev peak there is a sharp drop and then a leveling-off in prices, producing what is sometimes called the (price) plateau. The plateau ends with a second precipitous drop, or what is sometimes called the fall from plateau. This second drop bottoms in what has been called the vortex by the economist Brian Berry. The first three cycles following 1800 showed plateaus ending in 1818, 1872, and 1929. The vortices following the fall from plateau occurred in 1820, 1878 and 1932. These points are marked in Figure 1.
When I first developed the idea of reduced price in 2001, the only feature that had happened in he current downwave was the Kondratiev peak in 1981 and the beginning of what looked like a plateau in 1987. The plateau was apparently still continuing after 14 years. This was far longer than any previous plateau had been, which led many Kondratiev cycle observers to conclude that the plateau had ended in a way that was obscured just as the cycle is obscured in the raw price data. Based on my reduced price measure, I was of the "extended plateau" school that held that the cycle has lengthened after WW II. With the end of the secular bull market in 2000 I expected that in the very near future we would see a sharp drop in reduced price indicative of the end of the plateau. As Figure 1 shows this sharp drop did finally occur in 2008-2009. This observation confirms our current position in the downwave as a year after the vortex, which corresponds to 1821, 1879 and 1933 in the previous three downwaves. Based on these examples the Kondratiev trough is 13-21 years away or in 2023-2031, or 77-85 years after the last trough in 1946. This would make the length of the current Kondratiev cycle about eighty years, more than 40% longer than its historical length.
The ends of secular bear markets have occurred close to previous Kondratiev peaks and troughs. The seven secular bear markets since 1802 have ended in 1815, 1843, 1861, 1896, 1921, 1949 and 1982. All of these are within three tears of either a Kondratiev peak or a trough. At the earliest, the current secular bear market should then end three years before the end of the current downwave or in 2020-2028. The longest secular bear market to date has been 20 years. The figure at the top of the article shows that this current secular bear market has developed at a rate very similar to previous ones and should easily by finished by the end of a 20 year period. Therefore I still favor an end to the secular bear around within a few years of 2020.
Figure 2. The length of the Kondratiev cycle over time
We can get a more accurate picture of Kondratiev cycle length by measuring the spacing between at the labeled points in Figure 1. I did this for the peak, trough, vortex and the midpoint of the plateau. Since the Stock Cycle is so well correlated with the Kondratiev cycle I also used the beginnings of secular bear markets (which fall mid-way between Kondratiev peaks and troughs) to obtain additional points for comparison. The spacing between two-apart secular bear markets then defines a Kondratiev cycle. I plotted all these spacings in Figure 2.
Since WW II the cycle has clearly steadily lengthened. I believe the cause of the modern, longer Kondratiev cycle is government policy as dictated by political cycles that follow my paradigm model. Rather that going into the model in detail, it is useful to note several explict examples of how political actors have taken steps to lengthen the current downwave. If the old cycle length of 53 years were still valid one would expect the most recent Kondratiev peak to have happened in the early 1970's. Indeed, commodity price inflation rate peaked around 1973 and a serious recession occurred. Inflation did not abate after this recession; commodity prices and particularly gold prices soared in the late 1970's before peaking in 1980. After 1980 there was a serious recession after which inflation did subside, which makes the Kondratiev peak in the early 1980's--not around 1973--as is clearly indicated by reduced prices.
Now why did inflation subside after 1980 but not 1973? The answer is that the Fed deliberately induced disinflation after 1980, but did not do so after 1973 because the political authorities of the early 1970's were unwilling to throw millions of Americans out of work in order to quell inflation. Unemployment was still seen as more problematic than inflation in 1973. By 1981, the political winds had changed and it was now politically feasible to trade unemployment for lower inflation. Hence the disinflationary recession was delayed 8 years from 1974 to 1982, lengthening the K-cycle.
The next lengthening occurred in 1997, when Congress passed a capital gains tax cut in the face of an already overvalued stock market. This policy was justified by the idea that cutting the tax rate would generate more tax revenues because it would stimulate capital gains. The policy worked as intended, a modestly overvalued stock market expanded into the largest bubble in history over the next three years, creating lots of capital gains and lots of capital gains tax revenue. This act of Congress succeeded in delaying the end of the bull market by three years.
With the collapse of the stock market the stage was set for a serious recession and the fall from plateau. Sharp rate cuts by the Fed provided support to a rising real estate market, preventing any decline in real estate activity during the 2001 recession. This support helped make the 2001 recession very mild. By 2003 real estate was moderately overvalued, like stocks in 1997. At this point Congress again passed a capital gains tax cut, which worked like the first one to produce a massive bubble in asset markets. The only difference was in 1997 stocks were the most popular asset class and so it was the stock market that developed a bubble first whereas in 2003 the popular asset class was real estate and so the bubble developed in real estate.
When the real estate bubble collapsed, the Fed was no longer able to prop up the markets and we got the fall from plateau, about 8 years delayed. Cumulative lengthening by explicitly political actions now has gradually added two decades to the length of the Kondratiev cycle over the past four decades, which agrees nicely with Figure 2.