Chart of the Day - Inflation Adjusted Dow

The following chart (courtesy of chartoftheday.com) shows that the current market valuation is right in the middle of the historic price range band. It is interesting to note that the two previous declines within the band took approximately 20 years (1929-1949) and 17 years (1965-1982). A similar time span now would extend to 2024-2027, using 2007 as the top, and 2017-2020, using 2000 as the top.

This chart takes me back to two previous articles looking at reversion to the mean for stocks (here and here). These articles took two somewhat different views of how long range cycles could be viewed in evaluating the current market.

Both articles show how, historically, stock market performance and valuations have cyclically exceeded means and then gone below long-term averages. Right now, both articles show metrics that are near means after an extended period of time above average. The implication is that we have a number of years coming below long-term averages, if historic patterns are to be repeated.

The Chart of the Day is another expression of the same story - near average position following a long period of time above average. Will the pattern of history be repeated? Will we have several years of underperformance yet to come for stocks?

Comments

[Dirk McCoy:]

For those who apparently didn't appreciate my commodities comment, perhaps you should consider how much steel will be going into cars built over the next 20 years, vs. how much steel content is in the clunkers that are being turned in for metal reclaimation.

Given the auto reclaimation market was enough for about 14 million cars manufactured to the old fuel economy standards, don't be surprised to see iron consumption in the auto industry plummet, and long term, it could be like steel used in beverage containers as composites are used to a greater extent.

Meanwhile, Alcoa has shuttered 40% of their production capacity, and there are substitutionary materials for aluminum...

Jun 20 03:53 PM

[Mayascribe:]

John: Always love your stuff.

Perhaps this chart may be skewed a bit as i) it does not include the huge amount of ETF's that have sprung up recently ii) you would know this better than me--I believe that there has been a huge increase (proportionately to the past) of recent secondary offerings, common or preferred iii) many investors are choosing now to buy preferred shares and corporate bonds rather than common stock.

I realize that a lot of companies have plowed the preferred into common, such as Bank of America has done. But I think this still does not offset the huge increase toward corporates and preferred, especially in the case of Uncles Sam's "chuck-a-bucks" buying up the preferred of so many banks.

I have know idea of how much this affects the common stock of DOW companies and their shareholders. But I believe that a much greater percentage than "normal" is going toward corporate bonds and preferred shares, which may have vastly reduced the chance of those common stocks of regaining their last years highs.

In short, the adding of so many investment vehicles, as well as how easy it is for a peon like me to set up an e-trading account, which has access to nearly all the above forms of investment vehicles, leads me to believe that their is a greatly reduced percentage of monies going toward common stock than in the past that nobody seems to be talking about.

Jun 20 04:21 PM

[Brian McMorris:]

Great chart. It is always good to take "REAL return" into consideration and not just nominal. Still, this chart is not as scary as it looks. With our current Fed, Treasury and Administration, there is a great commitment to stopping deflation. That is a much more painful way to experience the type of long term (Elliot Wave) cycle this chart describes. But the 1968 to 1982 wave was much more peaceful. The DOW was essentially flat over that time (at 1000), but inflation cause the value of a dollar to drop resulting in the inflation adjusted chart above. If we repeat this pattern, it is likely to be like the 1970s version of the decline, not the 1930s deflationary type. With inflation, there are good strategies to actually move returns ahead, basically buy Real Assets like metals, energy, gold and real estate (once the crash is complete). I predict we get back to 14,000 DOW within five years, but may encounter inflation to accomplish this feat.

Jun 20 04:32 PM

[Brian McMorris:]

If there was a head and shoulders in this chart, the head was 2000. that means 2007 was the right shoulder and we are at the bottom of the valley completing the bear cycle. Volume is ALWAYS low at the bear bottom as many people lose interest in stocks, or are still licking their wounds and afraid to go back in. I think your reading is completely incorrect.


On Jun 20 08:55 AM long_on_oil wrote:

> All charts are meaningless for future predictions because only one
> thing effects the future and that is demographics. The United States
> is an aging country that will never see the growth of the past again.
> It is like an individual that compiled a life savings and is now
> retiring and spending the savings.
> We are going to let the rest of the world produce the products that
> we will purchase because we don't have the workers willing to work
> for pennies on the hour making clothes, trinkets and all the other
> inexpensive items we use everyday.
> China, Brazil and the other third world countries will develop as
> we pick up the tab.
> For the Dow to see 14,000 again it will have to made up of multi-national
> companies that do most of their business out of the United States.

Jun 20 04:41 PM

[Brian McMorris:]

Those who use Japan as a potential comparison to the USA really miss a number of important differences in the two economies and also the world setup. 1. Japan's stock market had an AVERAGE P/E of 100 in 1989. What was the Dow or SP500 in 2007, 20? No comparison at all. The Japanese stock market and all other assets, like Tokyo Real estate ($10,000 / sq. ft.) were ridiculously overpriced. They had a lot of correcting to do to get back to normal GLOBAL averages. Now they are in line. 2. Japan is a closed society and a closed island economy. They have no natural resources with which to expand their economy and the population does not consume its own goods. This means Japan can only grow its economy by exporting consumer goods and must import its raw materials. In 1980, this was not a problem. There was no global competition in the consumer goods manufacturing space. They had it all to themselves and had a great 10 year run. But in 2009, there are many global competitors with lower costs and some having their own natural resources which lowers input costs (China). Japan must become more like Europe and America and develop a consumer society or it is stuck in economic Pergatory. 3. America has a much more dynamic financial system that is inherently more willing to admit its mistakes and move on. The tough love of the past two years in the banking system (Bear Stearns and Lehman forced bankruptcies, along with AIG and Citi) could not have happened in Japan. There is too much honor at stake there. Here honor means very little (which at some times seems pathetic, but is good in the long run to fix problems). Similarly, because honor was not an issue at the Fed, but more important was pragmatic problem-solving, we saw Bernanke do an about face and flood the economy with liquidity, something Japan did not do until 10 years too late. I could go on, but space is tight. Again, there is no comparison between America and Japan economically and people should quit making such a lame analogy.


On Jun 20 10:22 AM AndrewBaker wrote:

> I use technical analysis a lot, and as most technicians will know,
> the choice and drawing of trendlines is as much an art as a science,
> if not more so, and interpretation can be very individual. Here,
> if you draw a static (horizontal) as opposed to dynamic (diagonal)
> trend line across at DOW 5000, you will see a strong support line;
> strong as it is confirmed by many previous support and resistance
> points on the chart. That gives an argument for the bears who see
> a 550 level on the S&P 500: a similar percentage drop on the
> DOW will give 5000.
>
> Those who will deny this possibility may care to consider the case
> of Japan: From near 40,000 on the Nikkei 225 20 years ago to 9890
> currently.
>
> Food for thought, IMHO.

Jun 20 04:55 PM

[Brian McMorris:]

Good post Dick. I see it more or less the same as you. However, I am in commodities right now for the short haul. You are right, in the long run, oil and coal will become obsolete with the further development of solar energy (of which wind is one form). Fuel cells will allow us to harness solar energy through conversion of water to hydrogen (by applying solar electricity) and then back again to water. But that is a 20-50 year thesis. The near term thesis (next 10 years) is lots more oil as the developing world grows. My retirement depends on near term theses.

Sad to say, but in the long run, we all are dead.


On Jun 20 11:19 AM Dirk McCoy wrote:

> If you use history as a guide, commodities eventually disappoint
> because technology consistently creates substitution, productivity,
> and efficiencies- just look at the price of silicon for solar panels
> the last year as new capacity has exploded on the scene, and consider
> the effects of glass fiber and copper-coated aluminum on copper.
>
>
> Meanwhile, the DJIA are the companies that ARE looking for growth
> outside the US (or doing business with those companies) and when
> 3 billion people still live on less than $3 a day, you're a fool
> not to realize there's a ton of opportunity for economic growth around
> the globe.
>
> While bloated government and protectionism may threaten our competitiveness,
> the pendulum can only swing so far before the electorate reconsiders.
> It happened in 1980, it can happen again.

Jun 20 05:03 PM

[Brian McMorris:]

There is technical analysis that tries to put numbers and patterns on human emotions / greed and fear, and then there is voodoo. This is voodoo.


On Jun 20 12:30 PM Ivo P. Janecka, MD, MBA, PhD wrote:

> The estimated timeframe for the bottom of market valuation, 2027,
> mentioned in this article, is very similar to the year 2028 arrived
> at through calculating sequences of Kondratieff waves on a commodity
> prices chart starting in 1730.
> Since late 1700s, the Kondratieff waves have been running in pairs
> of shorter and shorter duration with also narrowing differences among
> the pairs (initially +/- 3years, then +/- 2 years, and the last pair
> differed only by +/- 1 year). Extrapolating this pattern forward,
> the next major bottom does appear to be the year 2028. For specific
> dates, please see InstaBlog Seeking Alpha from 6-2-09 at seekingalpha.com/insta...
>
>
> The original chart used for these calculations was James Flanagan’s
> (Gann Global Financial) “Commodities Prices since 1730” recently
> published on seekingalpha.com/artic...

Jun 20 05:07 PM

[Brian McMorris:]

Exactly Spartacuss! Technical analysis is only useful if it is analyzing something other than itself. As I said a post ago, there are patterns that may be based on primary human traits like fear and greed. That explains why charts overshoot the mean in a consistent way. I also believe in the "Elliott Wave" pattern only because I think it describes generational memory (30-40 year full cycles). It seems everyone gets to experience both a boom and a bust during the key investing years of their lives. And if they get "busted" they aren't likely to repeat that pain. But beyond that, trying to glean meaning from a chart purely on its patterns, is "voodoo" as I call it.


On Jun 20 03:10 PM Spartacuss wrote:

> Ahh, how we impute from the past what the future must be. Everyone
> these days is in the business of parrallels. In statistics class
> in my engineering studies I learned that a thing cannot be a function
> of itself.
>
> Single function charting proves only that things change in recognizable
> patterns, however to forecast that the pattern will always retrace
> simularly is folly. for example: a tossed coin shows heads ten times
> in a row, does that mean on the next toss we will get heads?
>
> There needs to be connectivity, that is, cause and effect and for
> this we look at fundamentals and to understand that is to summarize
> market trends and shifts in economic and productivity models. The
> world is constantly changing and these changes if fully understood
> lead the way to predicting future markets notwithstanding emotionalism
> which seems to be very pervasive these days. However, no two people
> will, for the most part, fully agree on the fundamentals, however,
> the technicals provide in the rear view mirror, a non controversial
> portrayal of what happened. However, to bet your bottom dollar on
> it, well, that is another matter.

Jun 20 05:15 PM

[IndidnaJohn:]

As the talk talks and years go by I am more and more amazed, although not dazed by the current market psychology and commentary. As a long term subscriber to; 'The Dines Letter', I am prepared to meet this market for years already. How is it that the pioneer (James Dines), is so unmentioned, anywhere, all of the time?
Well after all, his secret codename is; 'nobody'. -- IndianaJohn

Jun 20 06:54 PM

[whatanorder!:]

Wow! That 1929 decline was STRAIGHT down!!! I've never seen it so well represented graphically.
Thanks
:-)

Jun 20 08:28 PM

[John Lounsbury:]

Commenters - - -

Great job. To those who wonder why I didn't draw some other possible trend lines, support lines, etc., I simply reproduced the chart as published by chartoftheday.com. I agree that a number of meaningful lines could be drawn on this chart, other than the ones provided.

I don't know if it could be done very easily, but wouldn't it be great if a chart could be put up and commenters would have the ability to add lines and notes as they saw fit, with each individual anotated chart posted as a comment? We could have a couple of dozen individual views of a given chart, some with overlapping meaning and some with contradicting meaning.

Any thoughts?

Jun 20 08:34 PM

[Dirk McCoy:]

John,

Perhaps you could import the chart data into google spreadsheets and give us all the log in password.

Although that, and moderating it, sound like way too much work to me.

Jun 20 10:27 PM

[John Lounsbury:]

Dirk - - -

I'm going to try to share this idea with some people who may be more creative than me. It would be fun to try if the right tools could be managed without becoming a burdensome chore for the "caretaker".

Jun 20 11:43 PM

[Steven Hansen:]

there is so much pressure today to have the market define the economy (and the pressure on the economy for it to improve), i wonder if there will be any downside correction as some see in the tea leaves of this chart.

Jun 21 12:17 AM

[Donald Ingram:]

In my opinion you are wrong. You can not take Kondratieff's original wave theory and make the wave frequency fit the data. That would be contrary. His 120 year epoch wave cycle is what it is. Period. Due to bottom March 2014. The 60 year tech wave due to bottom May 2011. The 30 year Kusnet cycle due to bottom December 2011. The 10 year Juglar cycle due to bottom January 2012. Last but not least the 6 year Kitchin cycle due to bottom June 2014.

These waves are regular with a given frequency, that for the most part, peak and bottom with consistency and reliability. Changing the wave period and frequency to fit the data as you want it to be, corrupts the outcome and makes your conclusions pointless. Jun 20 1
2:30 PM Ivo P. Janecka, MD, MBA, PhD wrote:

> The estimated timeframe for the bottom of market valuation, 2027,
> mentioned in this article, is very similar to the year 2028 arrived
> at through calculating sequences of Kondratieff waves on a commodity
> prices chart starting in 1730.
> Since late 1700s, the Kondratieff waves have been running in pairs
> of shorter and shorter duration with also narrowing differences among
> the pairs (initially +/- 3years, then +/- 2 years, and the last pair
> differed only by +/- 1 year). Extrapolating this pattern forward,
> the next major bottom does appear to be the year 2028. For specific
> dates, please see InstaBlog Seeking Alpha from 6-2-09 at seekingalpha.com/insta...
>
>
> The original chart used for these calculations was James Flanagan’s
> (Gann Global Financial) “Commodities Prices since 1730” recently
> published on seekingalpha.com/artic...

Jun 21 03:03 AM

[Donald Ingram:]

John - Thank you for the chart and the links to the two other charts.
They support Kondratieff's original wave theory.
120 year Epoch cycle.
60 year Kondratieff wave.
30 year Kusnet cycle.
10 year Juglar cycle.
6 year Kitchin cycle.
Gann, in my opinion, did the wave theory a disservice by attempting to shorten the cycle and therefore 'bunch up' the frequency to fit his data. The data he collected may be 'truthful' and historical, however customizing the wave theory to fit this data, returns useless and misguiding information. Please see my above comment to Ivo P. Jane, to see the projected bottoms of these waves and cycles.

Jun 21 03:16 AM

[Michael Clark:]

36 year cycles, 18 years up, 18 years down. The last Day Cycle (expansion) was 1983-2001 (when we should have begun tightening interest rates. We know what happened instead.)

The current Night-Cycle (Contraction, De-Construction) will run from 2001-2019.

These numbers are very similar to the author's above.

A draft of my book describing these cycles is available at

www.hoalantrangallery....

Period A. 2001 – 2019: Night Cycle Deflation, Social Fragmentation, Chaos
Period B. 1983 – 2001: Day Cycle Inflation, Higher forms of Organization
Period C. 1965 – 1983: Night Cycle Deflation, Social Fragmentation, Chaos
Period D. 1947 – 1965: Day Cycle Inflation, higher forms of Organization
Period E. 1929 – 1947: Night Cycle Deflation, Social Fragmentation, Chaos
Period F. 1911 – 1929: Day Cycle Inflation, higher forms of Organization
Period G. 1893 – 1911: Night Cycle Deflation, Social Fragmentation, Chaos
Period H. 1875 – 1893: Day Cycle Inflation, higher forms of Organization
Period I. 1857 – 1875: Night Cycle Deflation, Social Fragmentation, Chaos
Period J. 1839 – 1957: Day Cycle Inflation, higher forms of Organization
Period K. 1821 – 1839: Night Cycle Deflation, Social Fragmentation, Chaos
Period L. 1803 – 1821: Day Cycle Inflation, higher forms of Organization
Period M. 1785 – 1803: Night Cycle Deflation, Social Fragmentation, Chaos
Period N. 1767 – 1785: Day Cycle Inflation, higher forms of Organization

Jun 21 05:37 AM

[SageNot:]

Being more of a" seat of the pants analyst" myself than a grad analyst, most of you guys are like Wall St. Week's annual "guessers!" Guessing is guessing, where's the beef?

Buy & hold is dead for now, maybe forever, get over it. I spent more than half my Wall St. career in futures, mostly during the '80's, & stocks were as volatile as commodities were back then. There is no way that commodities can rally for years w/o growth in stocks related to commodity usage, got that, NO FREAKIN' WAY!

So if the futures folks think that the commodity boom will last for years to come, HOORAY! Jim Rodgers can be, & often is, DEAD WRONG, ask his old partner, Geotge Soros. Better you guys who disagree read some of Dennis Gartman's daily messages, he certainly knows that buy & holds is dead, & he knows commodities better than most.

14K Dow means what, I'd settle for 10%/12% per year for the next decade, knowing full well that some years won't deliver that return, but one or two years will perform better, maybe much better. You need to have skin in the game, use trailing stops that protect principal (w/o which you have today's situation for millions of retirees who've lost more than half their retirement stake.)

Happy Father's Day!

Jun 21 09:46 AM

[Michael Clark:]

The problem with the Republicans is that they are now scarred with the stigma of being the part of the Undisciplined Businessmen who have destroyed our economy. The same way that Herbert Hoover became the symbol of the Great Depression, Bush/Greenspan/Paulson... are now the symbols of this Great Depression. We have NOT seen the worst of it. It will be another generation before Americans will begin to forgive the Republicans for destroying the American working and middle classes (white AND other races and colors).

Jun 22 01:03 AM

[TeresaE:]

It is not that we "don't have workers willing to work" for pennies.

It is that we CAN'T AFFORD to work for pennies.

The real problem is that in our current litigious, protectionism, union, tax heavy system, business CAN'T succeed. Especially small to mid sized.

Our entire country is now built on international mega-corporations comparing our wages to the third world's.

We would work for "pennies" if we could feed our families and keep a roof over our heads.


On Jun 20 08:55 AM long_on_oil wrote:

> All charts are meaningless for future predictions because only one
> thing effects the future and that is demographics. The United States
> is an aging country that will never see the growth of the past again.
> It is like an individual that compiled a life savings and is now
> retiring and spending the savings.
> We are going to let the rest of the world produce the products that
> we will purchase because we don't have the workers willing to work
> for pennies on the hour making clothes, trinkets and all the other
> inexpensive items we use everyday.
> China, Brazil and the other third world countries will develop as
> we pick up the tab.
> For the Dow to see 14,000 again it will have to made up of multi-national
> companies that do most of their business out of the United States.

Jun 22 10:11 AM