Using the Ka-Poom Theory to Invest After Black Swan Events

In this post, we'll take a look at the the Ka-Poom Theory, a framework for investing in "bubble" economies -- economies driven by the creation of asset bubbles.

Ka-Poom Theory: What It Is

The Ka-Poom Theory is a theory that postulates how the asset bubble cycle works -- meaning how bubbles are created, destroyed, and reborn. It was developed by Eric Janszen, former venture capitalist who now writes commentary at iTulip.com.

The Ka-Poom Theory offers the following framework for understanding bubble cycles:

1. The Bubble is created. Ka-Poom Theory posits that the creation of the bubble is a result of interest rates being kept too low by the central bank. This is the same conclusion reached by the Austrian Business Cycle Theory.
2. Also like Austrian Business Cycle Theory, Ka-Poom Theory expects the bubble to begin deflating at some point. In addition, though, Ka-Poom Theory expects a "black swan event" -- an unpredictable, external, outlier event that has a monumental impact and, in the context of Ka-Poom Theory, a deflationary effect. It does not, however, cause a deflationary spiral where the price of everything spirals downwards, and money becomes the critical scarcity. Thus, Ka-Poom Theory refers to this state as disinflation.
3. The central bank will respond to disinflation with inflationary policies that will take approximately 12 months to impact the markets. The period of disinflation will be erratic.
4. The black swan event is the "ka" of the Ka-Poom Theory. The "Poom" is the subsequent re-inflation of the money supply. Deficit spending and inflationary policies initiated by the Fed dictate to what sector the re-inflation of the central bank will go.

The Ka-Poom Theory posits that this is what has been happening in the US economy since the dot com bubble, and thus is the current framework for understanding the US economy.

Assumptions of Ka-Poom Theory

The most critical assumption the Ka-Poom Theory makes is that the central bank has the power to inflate the market at will, invariably. In other words, the Ka-Poom Theory is based on the premise that if the Federal Reserve wants to inflate and create higher prices, it can -- by printing money, buying up assets, working through the credit market, or inducing foreigners to sell Treasury bonds and dollar holdings. It also assumes that the results of the central bank's actions are not instantaneous; the gap between their policy enactment and the corresponding re-inflation of asset prices is a period referred to as disinflation.

Because of this assumption, the Ka-Poom Theory is essentially a framework for understanding how a planned economy works.

Implications of Ka-Poom Theory for Traders and Investors

To the extent that Ka-Poom Theory is valid, a few deductions can be made for traders and investors:

1. The period of disinflation -- what Ka-Poom Theory argues we are in now, which is characterized as the period between the Federal Reserve's policy enactment and the corresponding effects -- is deemed to be erratic. Janszen prefers to stay out of the market during these times.
2. In a debt-based bubble, the long-term bond market will likely be where the arbitrage opportunity is, in the sense that bond prices will fall as the market begins to re-inflate.
3. In order to understand what sectors will be set to inflate -- where the next bubble will be found -- Ka-Poom Theory looks at government spending to lead the way.

Comments

[Larry House:]

Very interesting comments. Thanks. The theory doesn't seem to give any weight to the consumer impact on the economy. The Fed can print money, but they can't make people spend. If we are entering a new era of less appetite for spending and more desire to save, (and many think we are) then the attempt to reinflate may not have the desired effect or the degree of effect. I certainly agree that the period we are in is a time to avoid equities except in very limited ways. We are truly in the midst of financial history being made. Keep expectations low and the safety level high.

Jan 15 10:13 AM

[L Boyd:]

Indeed an interesting article - thanks for sharing.

@Larry - I agree with what you say. So if I were to agree with the Ka-poom theory AND Larry's analysis (which I do) I'm going short the U.S. dollar, big time. If you are pumping massive amounts of cash into the economy but it is not being invested in appreciative assets or spent by consumers (thereby leading to capex) you have a huge supply of dollars that aren't doing anything to grow the U.S. economy. Sets the stage for massive currency devaluation.

Jan 15 11:20 AM

[carey_jim:]

I like the name. It sounds like a rap.

Ka Boom,
Ka Boom (the Black Swan event)

Ka Poom
Ka Poom (the strategy)

Sha Boom
Sha Boom (the outcome)

All sung, of course, to the tune of the song Life Could be a Dream www.youtube.com/watch?...

Lyrics: www.geocities.com/bjae...

Jan 15 12:02 PM

[Alex Filonov:]

How Ka-Poom theory explains what's happening in Japan in the last 20 years? My answer: it doesn't. The whole world now looks like Japan did in 1990. Why would we believe Ka-Poom theory?

Jan 15 01:45 PM

[unimpressed...:]

More bullcrap to dazzle the innocent and baffle the knowledgeable. This is a perfect example of why I have never paid any attention to analysts and pundits. As the old saying (wisdom) goes: Those that can, do; those that can't, write articles and create useless theories".

Jan 15 02:31 PM

[scotty1560:]

agree with Alex...and wouldn't be in a hurry to short the dollar...Euro could be
toast in 5-10 years...dollar is still the safe haven.....pound is toast...

we are Japan circa 1990 or US circa early 1930's....a few years into a 20-25
year cycle based on demographics....Baby boomers have peaked and
will scale back.....will take a generation to heal and forget to forge on
to the next boom cycle...we have enough homes for 100 years...it's over
other than trade opportunities and agriculture...maybe peak oil in a few years..

India will rise in a few years along with China to lead world economies..

Jan 15 09:41 PM

[dscianni:]

Looks like you forgot to name your sources for this theory...

I can think of at least a couple of well-known blogs, which should be given their due credits.

Jan 16 07:44 AM

[bigmoney:]

Ka poom theory seems to be very fashionable these days. First disinflation, then heavy inflation. However, peak demographics (at least in western cultures) and fossil fuel contraints seem like they will be a long term head-wind.

Any "Printing money" is likely to end up in the hands of the few, the top 10%, or even 1%. And I have read that the richest 1% own a majority of stocks and bonds. So perhaps that will facilitate inflation. At a minimum asset price inflation.

Jan 16 11:45 AM