Will the 8-year Cycle Bring Down the House in 06?
With the current 8-year cycle getting closer to its bottom later this summer, it's only natural to ask if the financial markets will experience a similar reversal and period of extreme weakness such as the case was in 1998 when the previous 8-year cycle bottomed. The 8-year cycle decline of '98 brought disastrous consequences to some emerging economies and nearly brought down the global financial system with it. So it behooves us to ask whether 2006 might witness a similar global financial and/or economic crisis.
But first, how important is the economy when it comes to the health of financial markets including stocks? Are the two mutually exclusive? Does the stock market predict turns in the economy (as the Dow Theorists believe)? Or does the economy precede the stock market?
These are simple questions to an exceedingly complex subject. And since the growth and integration of the global economy in the last 8-10 years it becomes even more complex. In short, while there is no simple "yes" or "no" answer to these questions there are some important observation that can be made based on both recent and distant history.
Some may wonder why even bother to bring this question up. To many, the state of the economy is largely a passing concern and of no immediate interest to their actions as traders or investors, especially in the natural resources sector. Yet an examination of the economy-stock market connection can yield some important clues as to what we can expect in the months and years ahead for the U.S. markets as well as for the emerging global economy. It is also important that we look at the question of economy as it relates to the stock market in view of the fact that this year is when the latest 8-year cycle bottoms. You may recall that the previous 8-year bottom in 1998 was accompanied with strong selling pressure in stocks, commodities and foreign currencies as well as major economic weakness in some regions of the globe. With the Long Term Capital Management debacle, some even say it almost brought down the global economy. So it's only natural to ask as we approach the bottom of the latest 8-year cycle once again this year, "Will the 8-year bottom bring down the proverbial house as it almost did in '98?"
Let's go back to 1998 for a minute. There are more than a few similarities between '98 and '06. For instance, the acting president at that time, Bill Clinton, was in the second year of his second term in office -- just as George W. Bush is today. Clinton had a public relations nightmare beginning in 1998 after the Monica Lewinsky scandal broker early that year. His public approval rating suffered for it as calls for impeachment were heard. Bush has also had his fair share of public approval woes this year, mostly relating to the conflict in Iraq (although Bush's popularity is admittedly much lower than Clinton's ever was in the opinion polls).
But one thing Clinton had going for him back then was a strong economy that he could point to in order to deflect outrage over his scandal. A strong economy is a proven panacea for anything that ails a government leader and Clinton banked on his knowledge of this fact to get out of his personal troubles. Is the economy as strong today as it was back then? It depends on who you ask, but no, certainly the domestic economy isn't surging today as it was back in '98. One reason is because at that time the oil price was closer to $10/barrel and gasoline in many cities cost just under $1/gallon! (The fuel situation of today has reversed to such a considerable extent that it almost seems as though the oil companies are making us pay for the "giveaway" prices of 1998.)
The Asian currency crisis began in the summer of 1997, which in turn started the fire that gradually spread around the globe from one major region to another, knocking down foreign currencies in its path, tripping developing economies and eventually bringing down stock prices as well. No major economy was unaffected it seemed, and by the following year even the U.S. had begun a bear market in stock prices that was vicious in its severity despite its brevity. The Asian crisis created great hesitancy among investors for emerging countries and this in turn led to sharp declines in key commodity prices (including oil). Countries affected by the post-Asian crisis recession included Russia, Thailand, Indonesia, South Korea, the Philippines, Japan and to some extent the United States.
As a result of the financial market gyrations that began in July '97 and continued through 1998 many investors lost a fortune. Some lost virtually everything, including the well known speculator Victor Niederhoffer, whose firm lost over a hundred million in one day back in October '97 over the so-called "Asian Contagion" and was forced to close down. (Niederhoffer made a remarkable comeback the following year, however, and managed to recover all his losses in the subsequent two-year period. This account is briefly touched upon in his 2003 book, Practical Speculation, an interesting read).
Another major factor at that time was the strength in the U.S. dollar. This made the exports of many Southeast Asian nations less competitive due to currency pegs and consequently caused a slowdown in export growth. The "strong dollar policy" was one of the hallmarks of the Bill Clinton/Robert Rubin economic policies of the late '90s and was one of the factors in the crisis of '97-'98.
The gold price naturally fell during this period of global weakness from 1997-1998 and didn't actually bottom until later in '99. Many key agricultural commodities were also down until '99. The environment of the late '90s was very much one of deflation and during the "hard down" phase of the 8-year cycle bottom of 1998 many commentators were heard to say that commodities as a whole were on the very brink of collapse. The CRB commodities price index fell from its 1997 high of around 250 to a low of about 185, a multi-decade low.
Yet the 8-year cycle ended in September-October '98 and commodities didn't collapse, although much damage had been done to both stocks and commodities (to say nothing of Asian currencies). Some key commodities put in major long-term lows in late '98, including oil and gasoline. It had been a close call and one that summoned all the combined strength and acumen of the global financial controllers to keep the developing global economy at that time from breaking into pieces.
Fast forward to 2006 and here we are heading into the final "hard down" phase of the current 8-year cycle. Yet what is different about this time as compared to 1998? Quite a bit, actually, and that's why a repeat performance of that year is very unlikely to occur. The global economy is further advanced and closer to total integration than it was in '98 and Asian economies are vastly improved by comparison. The "strong dollar" has given way to the "weak dollar" and Asian economies continue to build current account surpluses instead of deficits. Instead of falling Asian stock markets, stock prices in those countries are on the rise and in some cases at all-time highs. Stock buybacks by corporations continue at record levels today rather than watering down shares as they did in the late '90s. And if you believe the numbers, the U.S. economy is in pretty good shape too. More importantly, global liquidity is at a high ebb and the overall environment is inflationary (or reflationary, depending on how you define it), not deflationary as it was in 1998.
The current price of gold says it all: there is a ton of liquidity in capital markets compared with eight years ago, and not withstanding inflationary pressures arising from higher fuel prices, this will translate into a strong backdrop for the global boom in stock and commodity prices to continue. It will also keep the major economies buoyant and away from the severe danger that some experienced in the deflationary environment of the previous 8-year cycle bottom in '98.
No analysis of the financial market outlook would be complete without a reference to the public's current psychological temperature. As chronicled in previous commentaries, fear has become one of the major watchwords of the first half of the decade and continues to be played up in the mainstream press on a daily basis. The widespread fear that was first engendered with the tech crash and 9/11 is another factor that wasn't present in 1998 at the previous 8-year cycle low. In '98 the public by and large took no though to the possibility of an extended bear market or economic recession. The virtually non-stop bombings we see today n the news weren't commonplace, and neither was the current extent of military conflict in the Middle East. By contrast, most Americans felt the country was at a permanent plateau of peace and prosperity and that the business cycle had finally been defeated.
The idea that a rising stock market is predictive of economic prosperity is a common one, in large part fueled by the writings of the early Dow Theorists and resurrected in recent years by a barrage of books and academic research in the wake of the late '90s bull market and economic super boom. But is this necessarily so? No, since most economic recessions and depressions could not possibly have been predicted by looking at the stock market as a barometer. This was true in 1970-74 when the U.S. economy bottomed out of its earlier recession and recovered for the next two years while stock prices continued to fall. It was also true more recently in 2001 when the economic recession at the start of this decade ended a full year before the stock market bottomed. If anything, Dow Theorists and others fail to give proper credit to the role provided by global liquidity and economic strength when assessing the financial market outlook. A strong or strengthening economy is a necessary prerequisite to a solid, long-lasting bull market in stocks and no stock market uptrend can be expected to last very long without it. This is one of the lessons of 1998 and is one reason why the U.S. markets were able to bounce back so suddenly in late '98 after the damage of the Asian Crisis at that time. It's also why a repeat of the financial market weakness of 1998 isn't likely to be as evident when the current 8-year cycle bottoms.
The painful 8-year cycle down phase that began in July 1997 with the Asian currency crisis and spread across the globe to other markets was but a birth pain of the emerging global economy. The hard decline in stocks and commodities at that time also allowed certain monied interests to increase their control and consolidation over key assets, thus paving the way for a strong finishing effort in the globalization process in the years that followed. Now that the global economy has been more firmly established and is closer to the Elitists' goal of total integration, it is doubtful that a repeat performance of 1998 is necessary.