Boom or Bust Cycle: Where Are We Now?

Includes: DIA, QQQ, SPY
by: Investment Pancake

It has been pointed out that stock markets tend to move in cycles, where boom periods (think 1920s, 1950s, 1990s) are followed by sharp busts (1930s) or lengthy, agonizing, drawn-out flat periods where inflation consumes most of the gains from the prior period (like 1965 to 1982).

We know that the past years have represented a terrible bear cycle, but the question on many folks' minds is, where do we stand in this cycle now?

It's easy enough to see from a chart that the Dow Jones Industrial Average hasn't budged much in the past ten years, so it's already looking a bit like we are well into a 1970s-esque investment epoch. Many have concluded that if the 1970s is the proper analogy, we only have six or seven more years of famine to go. Hurray!

But dig a little deeper. Let us assume that inflation rates have clocked in around 3% on average for the last decade or so. In fact, I'd think the rate of inflation is probably somewhat higher, but take 3% as a conservative estimate. Let's also look at the real purchasing power of the dollar. When first introduced, the Euro traded close to parity with the dollar, dipped down to about 90 cents at one point, and then began an epic climb towards where it is today - which I'll peg at $1.44 just for illustration's sake.

Using the Euro as an baseline for comparison, let us assume the dollar today is worth about one third what it was worth during the prior decade. Again, this is a hypothetical figure just for illustration's sake, because ideally, we'd want to use a far broader basket of currencies.

Today, the Dow Jones Industrial Average trades at around 9,300. Adjust that for inflation and the demise of the dollar, and what we find is that in fact, the last time the Dow Jones hit this level in real terms was when the Dow Jones traded around 4,000 back in 1994 to 1995.

In real terms, the U.S. markets haven't actually moved anywhere for nearly 15 years.

Does that mean we've come to the end of a 1970s-like stretch? Not necessarily. The 1970s was a period characterized by runaway inflation rates, far higher than what we've experienced in the last ten years. The true wealth destruction from 1965 to 1982 was far more dramatic than what we have seen to date - perhaps in the range of 60% or more.

So, let's look at it another way. Starting at the top of 1990s bull cycle. The last great bull market cycle probably ended in 2000 when the Dow hit 12,000. True, the Dow Jones did vault above 14,000 very briefly in 2007, but in inflation adjusted terms, that's lower than the 12,000 peak in 2000. If you assume 12,000 was the peak, then adjusted for inflation, the Dow Jones stood at about 15,700 in today's dollars. And adjusted for the deterioration of the buying power of the U.S. Dollar verses the Euro (again, assuming about $1.44 buys one Euro today), the Dow Jones would now stand at about 22,500 - nearly 13,200 points higher than today.

Look at it that way, and we've already seen a real loss of 60% in the U.S. markets off their true highs at the top of the last bull cycle. That is starting to look very much like the wealth destruction during wrought by the 1970s.

I don't know where we stand in the bear market cycle, and nobody else does either. What we can know, however, is that the current bear market cycle has been almost as bad as some of the others we've seen in history. And we can also know that after a really bad stretch in the market, usually a really good stretch follows.

For those with patience and a stomach for eating more losses that may or may not materialize over the next few months or years, the future should look brighter than it may at first blush.