Expansion and Contraction

Weekend Sunday Sept 23 2012

One reader asks TMP to explain what is meant by the periods of expansion and contraction. 

This is rough outline of the idea of Eras of Expansionand Contraction. 

Our Strategy will start with this  explanation in the forth coming iBook. 

Buy Low Sell High, A Strategy for Doing Just That

For whatever reason, the US Economy  and therefore the world, at least since Charles Dow created his Indexes, alternates by generation. This 'generation' breaks down into fairly clear eras of boom and bust. Now before you ask why, I don't know. Perhaps it is the market's way of fooling the next generation who is depending on the advice of their Fathers and Mothers, and they are fooled. The 18 year cycle may well go back much futher but we lack a handy index for tracking it. Other writers have worked on this topic. 

We will examine social mood more in detail in other sections of our strategy. For now, never mind why, just focus on what history tells us. The news media makes a living trying to link news to events, we try to link investing success to buying low and selling before the markets top out.

The creation of Market Indexes allows a handy way to track investments and positive social mood. Our friends at Elliott Wave have used other measures such as the Cleveland Trust Index which existed prior to Dow's Indexes to attempt to track the economy back further. But for our purposes, if we define modern times since about 1890-1903, this approach works. After all that time saw the introduction of the telephone, the autormobile,  Westinghouse Air Brake which finally made train travel reasonably safe, and then the ariplane, and indeed Stock Indexes. The introduction of the latter if you think about  it suggests that Americans had finally accumulated some real savings above and beyond daily needs such that an investment index had popular broad appeal. Of course just eleven short  years after Dow created it in 1896, Americans had already gone overboard and brought down the House with the Panic of 1907, that's Social Mood piling in at the last minute. But I digress, here is the beak down. 

Bear Periods

1894-1912

1930-1948

1966-1982

2000 - 2018 (Probable end date, we are 12 years into this stagnant era)

Bull Periods

1912-1930

1948-1966

1982-2000

It is vitally important to grasp this most basic macro concept, A series of charts demonstrate why. Let's go back to Great Granddad's investing era of 1912-1930. I began and ended this graph both before and after the period to show the dramatic spike at the end. 

Dow Industrials 1912-1930

While legend has it that is was the Roaring Twenties, the truth in looking at the graph is that the Era really only roared from 1925-1929 when the greatest percentage gain occurred. Recall a basic tenet of socionomics is that mood is strongest at the end of any era. Clearly that was true then and in later periods. 

Now here is why this is so important. Once one grasps the era one is in, the better strategy is clear. In the 1920s, you could have bought most anywhere along the line, better on pullbacks like 1915 during WW I of course, but in the end you would have made plenty of money. Actually one's overall returns are dramatically improved by taking advantage of severe pullbacks during periods of negative mood that do occur in expansionary eras. But we are staying big picture in this post. 

The bottom line is that in a period of expansion, buy and hold works. In a period of contraction, buy and hold does not work. So in an expansionary period stock selection takes precedence over timing. Now what next, well once one got comfortable with buy and hold from 1912-1929, things changed. 

Dow Industrials 1930-1948

Now, and again it is imperative that one grasp this about the era one is in. The Dow dropped a smashing 90% from the 390 high in October 1929 to a mere 42.84 on month end 6/30/32.  Wiping out 90% of the value of all stocks, note that were still trading!, in a mere 2.5 years is a depression indeed. No doubt the collapse of one third of all banks contributed heavily to this. But today we are examing the numbers of history not the whys and wherefores. One has to go all the way back to 1896 to see the 42.84 number, so the entire market was re-set to where it began withe Charles Dow. 

Note, does anyone today think we the market could go back in the next 2.5 years  to where it was 34-36 years ago, about two 18 year eras. That would be Year  1976 and the Dow was under 1,000. This is unthinkable now but it happened in 1932. The 1972-74 experience as just duplicated from 20007-2009. How quickly the public forgets. 

Clearly Buy and Hold did NOT work in this era. Indeed there was a huge rally from the 1932 bottom and again from the 1938 low and again during WWII from early 1943 as the outcome of the War shifted in the Allies favor. 

But again, the strategy if one is to be successful has to change. in an era such as this, one will have to be both long and then short the market at various times.

The only way to make money in the market is to be in tune with the market, period.

As Geroge Strait says, you might want to put that on the 'frigerator door.

Now let's move to the Baby Boomer era when I came of age.

Dow Industrials 1948-1966

Elmer Keltonn the famous Western authorn comments on his first purchase of a home 1948. He told his Dad the house was priced at $8,000. Dad's advice was, better wait son, the price will probably come down.

Dad was doing his best. Dad had been influenced by 18 years of hard core deflation. No one he knew had made money in real estate or stocks. And so as the new era took off, peple left their money in safe bank accounts not caring to lose their money as their parents had in 1932. Indeed there are still stories of people stuffing money in the mattress and all over their house rather than trusting a bank that could go bust.

Now look at the graph what do you see? It is a more gradual climb than in the 1920s but again the market really moved the last four hears from 1962-1966. By 1962 many people had seen others making money, the memory of 1932 was gone for most of the participants in the market (a very important point) and so social mood expanded towards the end of the move, taking the Dow from 600 in 1962 to its first ever four digit level, 1,000 by 1966, the Year I graduated from High School.

Let's mention that again. Generally it takes a lack of participants in the last era for the present era to be possible. There are fewer adn fewer people alive that lived through 1930-1932. That makes the posbbilibity it could happen again that much more realistic, think 2000-2003 and  2007-2009, when both Greenspan and Bernanke were at the helm. Note the FED has never prevented the crisises such as 1907 it was created to prevent. The FED is there for the banks, not you and I. 

And so all the Baby Boomers like myself has a wonderful life long experience of the economy always bouncing back. That memory would serve us poorly for what happened next. In 1966 America was watching The Sound of Music which won the Academy Award for Best Picture. By 1969 Midnight Cowboy had displaced Christopher Plummer and Julie Andrews, what a change. 

DJIA 1966-1982

This was not any fun, at all. It is no longer possible to ask LBJ, Richard Nixon, or Gerald Ford about their experiences. I wonder if Jimmy Carter realizes he came into the Presidency at one of the worst times possible while Clinton had the best, viva la difference  as the French say. 

At any rate, while I had no idea of eras at the time, this explains how the entire brokerage industry melted from 1972-1974 and began re-inventing itself as a discount house at the time, though again we had no way of knowing that. I began at duPont Glore Forgan in October 1972. Ross Perot maverick Billionaire was in control of the firm. Nixon trounced McGovern. Nixon and Kissinger would end the War in Viet Nam. The Dow had returned to 1,000. 

What could go wrong?

Just about everything as it turned out. The Dow melted from 1,000+ in early 1973  to a fateful 577 by December, 1974. Gasoline lines formed  from the Embargo and a possible Presidential Impeachment loomed. Flip Wilson went off the air. Bill Cosby had not been seen on tv since 1969. The Exorcist was the 'favorite movie' billed as the most horrifying show ever. Texas Chainsaw Massacre debuted near the bottom in 1974. I have a lecture on all that if you are interested.

But again the point is that in an era of stagnation, buy and hold would not work. 

Now, appreciate that markets move in fractals.

1966-1969 Down

1969-1972 UP

1973-74 Down

1974-1977 Up

The rest of the era was  down and then finally a huge move up once everyone was convinced no one would ever make money in the market again. That's social mood for you. But our point is this. If one had been able to take advantage of these moves by going long at bottoms and short at tops, there were huge returns to be made. 

DJIA 1982-2000

Wow!  I got in at the top with duPont Glore Forgan in October 1972, I threw in the towel by Sept 1974 just four months before the bottom. But appreciate I was a broker not an investor. And trying to make money was near impossible on a commission basis when no one wanted to invest. 

One of my friends from broker school got me re-qualified in 1983.By that time I had become a CPA and thought I might open a few IRAs for clients in mutual funds and such. I recall that at Dow 1200 three of us heard the CEO of our brokerage firm predict Dow 2000.. We all laughed and went to the bar, what on earth was he thinking?

Note I subsequently began an interest in technical trading which led to trading millions of dollar so fixed income securiteis and becoming one of the Top Brokers at First Affiliated Securities. Like Cliff Robertson in Charley or later Tom Hanks in Bonfire of the Vanities, it was a brief shot at being a Master of the Universe. Again that is another story. 

Bob Prechter's book on Elliott Wave was published in the late 1970s. He predicted a wild move to 3686. As Bob remarked, no one bought the book in 1979.By 1985 it was selling thousands of copies. 

The 1982-2000 era was marked by the 'discovery' of market successes like Warren Buffet and Peter Lynch. Value investing was discoverd again. But the era ended in a fit of non value investing as the public bid up the NASD by 2000 points in the last six months going into March 2000. This time the Tulip de jour was dot.coms, companies that only made money by going public, never doing what they claimed to do. Go figure,  a parabolic social mood moment. 

And now

DJIA 2000 to Now

Stockcharts has data from about 1990 and some earlier which allow for a much better chart. 

I stayed with this format for comparative perspective to the past eras. 

 

I altered the vertical scale to a 6000 to emphasize the huge moves of this era. 

This also demonstrates that the market moves in fractals, smaller time segments of the overall pattern. 

2000-2003 Down

2003-23007 Up

2007-2009 Down

2009- Now Up

2012 ????????????????

At this point readers might refer to the last two posts this weekend   where we show that 'you are here.' But even this simple graphic should demonstrate that risk has returned to the forefront, big time. '

Investors are at the same level of potential risk at in 2000 and Fall 2007. I hope that explains my exit from the market and attempts to vastly reduce my risk exposure. 

 

The Most Recent Fractal, 2009-Now

 

There have been many studies of frac tals in nature.

Consider how your mood can change even within one day. That is an example of mood or change breaking down into identificable segments. 

Now all we have to do is find a way to identify coming changes in fractals, mood and therefore marekt activity, and the Brass Ring is ours. 

That was of course a tongue in cheek statement. Many try few succeed.  

 A brass ring is a small grabbable ring that a dispenser presents to a carousel rider during the course of a ride. Usually there are a large number of iron rings and one brass one, or just a few. It takes some dexterity to grab a ring from the dispenser as the carousel rotates. The iron rings can be tossed at a target as an amusement. Typically, getting the brass ring gets the rider some sort of prize when presented to the operator. The prize often is a free repeat ride. The phrase to grab the brass ring is derived from this device. 

Conclusion

Markets move in alternating 18 year eras of boom and bust. The boom eras generally exhibit an overall upward trend. This trend accelerates towards the end of the era, typically in the last four to five years. Even in eras of upward trend, fractals exist which allow for significant pullbacks to discourage the long term investor. 

Alternate eras of stagnation follow 18 year eras of boom. These eras are marked by highly visible booms and busts as social mood  waxes and wanes. Typically the 18year era may end right where it started, this was the case more or less for  1966-1982. But if one can identify time periods moving from one extreme to the other, boom to bust or vice versa within the era there is money to be made. 

Here at TMP we are focused on doing just that. We hope you will join us and continue to provide constructive feedback. This look at past years is a quick rendering of our overview, apprecIate that I dashed this off early on a Sunday morning.  This is not a Random House publication with multiple editors. We do not have staff other than Bentely the Great Dane Hound Dog mix  and while he has his specialty, graphic design frankly is not one of them. 

I attempted to answer a reader question about periods of expansion and contraction. To that end, this serves a good purpose of asking for feedback on what you would like to see as we commmit these thoughts to our more formal and hopefully better illustrated iBook

Buy Low Sell High, A Strategy for Doing Just That

Cheers, we welcome all constructive feedback. 

 All thoughts and ideas here are those of the author, please do not post without reference to source. 

Thanks for reading The Market Perspective

Dennislelam@gmail.com

 

 

The Market Perspective bases its information on techniques and sources that have been found to be reliable in the past, and The Market Perspective tries to base opinions on sound judgment and research, however, we do not guarantee that future results will match past performance ands no guarantee can be made that advice will be profitable. The Market Perspective accepts no money for stock recommendations and is purely motivated by its own research in recommending any stocks.  Put another way, the responsibility for decisions made from information contained in this letter lies solely with the individuals making those decisions. The editor and persons affiliated with The Market Perspective may at times have positions in securities mentioned.  Nothing contained herein represents an offer to buy or sell securities. The Market Perspective encourages investors to be diversified, and to maintain sell stops and risk control over their valuable investment capital.  No guarantee can be made to the accuracy of text or charts.

 

 

 

 

 

 

 

 

Comments

[Random Wanderer]

If you would like to learn why there is a boom-bust cycle, study Austrian Economics. Here is an overview from someone who is well studied on the topic, follow the links within to dig deeper to more great articles:

Secular Cycles and the Stock Market by Pater Tenebrarum
http://www.acting-man.com/?p=10943

P.S. I just found your blog a few weeks ago and it is quickly moving up my list of favorites. I don't think the don't-fight-the-fed, the-trend-is-your-friend bulls have a clue how much risk they are taking to eek a few more points out of this market.